But this isn't earth, anyway, so most of this post is pointless
That is indeed true, trying to determine how Tamriel would really look based on real history always encounters this problem. It's fantasy, after all, if you're looking for a realistic portrayal of Medieval society, you probably shouldn't be playing the game where you can play as a cat man wearing armor made out of glass and using magic to save the world from hordes of demons.
Though, I'd imagine Tamriel would, in reality, be somewhat dirtier than we see in game, it probably isn't people sleeping in their own filth level of dirtiness, but it wouldn't be like what we see in Oblivion either. It would also depend on where you are, Bravil, for example, would be pretty dirty for the most part, whereas some wealthy noble in the Imperial City would probably get more cleaning done. That being said, however, even if we put aside the visual style of the games, the dialog or books in the games don't seem to suggest that things are all that bad either, and considering that some cities have been shown to have sewer systems, and sload soap is an item present in Oblivion (You know, soap, something people use for cleaning.) it would seem that some attention is paid to sanitation, how much attention? Not much information seems to exist.
I think it's really just due to the fact that consumers nowadays don't want to see a game where the NPCs are filthy and the castles are falling apart.
Looking at the trend of very "gritty" environments with lots of gray and brown in modern video games, I'd say that they in fact do, or at least it's what many designers THINK consumers want.
wouldnt the game go lagging if there was rubbish all over the place?
Not if Bethesda is ifficient about it, lots of games get by with lots of garbage laying around, even Fallout 3, using the same engine as Oblivion, had a fair amount of it.