The system folder is located on the root partition, which is only 500MB. Since the firmware for your iPhone 3G (2.x) is stored in the /root partition, it doesn't leave a lot of room for other things. For example Cydia jailbroken apps are installed in the root partition.
BigBoss has a utility called "BossTools" found in the Cydia installer that moves all your applications, system fonts and a few other things to the larger partition (/private/var).
I have a iPhone 3G running firmware 2.1 and have installed BossTools and have moved all my apps, fonts from /root to /private/var and everything works fine. After running "BossTools", I now have 165MB free on my /root partition.
For those interested in how it works, it moves the apps, fonts to the new location on /private/var and then creates symlinks (like shortcuts) in the original folder that point to the new location. If you know anything about Unix or Linux, you will understand.
Note: Another method for those who jailbreak, is to use PwnageTool and increase the size of the root partition so it is bigger than 500MB. I think BigBoss' BossTool is safe and works fine, but the choice is yours.
