Depending on how you look at the data, both cloth and disposable diapers have about the same impact on the environment. With disposable there's the impact from manufacturing and all of it ending up in the landfill. With cloth there's all the water, electricity, and detergent used to wash them.
This is a frequent topic on the Ask Umbra column on
Environmental News and Humor | Grist | 01 Jul 2008. You can search the archives to find all the articles she's written responding to letters. In fact, there was just one on June 18. The guy even had a handheld bidet to wash the baby's "deposit" into the toilet. Who knew there was such a thing. The article contains a link to a big Brittish study from 2005 comparing cloth to disposable.
There's another alternative where parents use no diapers and are somehow in tune with their baby's pre-elimination behavior and establish signals with the baby to tell them to wait until the parent can hold them over a toilet. You have to be able to hold your baby the majority of the time to make it work, though. There are also diapers with an absorbent cloth pad that's inserted into elasticized bloomer things so you only wash the insert and not an entire cloth diaper.
On the never-ending diaper ado | By Umbra Fisk | Grist | Ask Umbra | 18 Jun 2008
I'm not a diaper freak, the the way, I just used to work for the company that makes Huggies.