Oooh that's a nice effect--reminds me of a moving Victorian picture book. I think it could definitely be done, although you're right that it's hella more difficult to pick things out of full live action shots.
I don't know that I'd call myself an expert
but I have a few ideas... (and am assuming a default AE CS 5.5 install here just since that's what I have)
What strikes me about that video is that it works so well in part because of two things that will also make this kind of effect more possible for vidding.
Part 1. Most of the people aren't really moving that much. This means that if you were going to try and cut them out of a background, it's actually
much easier than if they were moving quickly with lots of different poses. How you want to approach cutting a character like this out from the background is with the pen tool (should be in the default toolbar just below the "Effect" menu), looks like a fountain pen.
a. Go around the outline and click on points where the curve of the character's silhouette changes (so, say shoulder, elbow, wrist of someone's bent arm, then around the hand, then back, etc.). When you click, a little square should be created with arrows sticking out of it (if there aren't any arrows, clicking on the square with the arrow tool--all the way to the left in the default toolbar under the "File" menu--should reveal them), and as you click on multiple points (go around the silhouette in a circle) a line should be created connecting them. The fewer points, the better.
b. As you're doing this, pull the arrows on the squares around until the line connecting the squares follows the silhouette of the character. Try to make the lines work together so none of the arrows are pulled out way far away or crazily distorted.
c. The last point you click should be the first square you created; the pen tool should have a funny circle next to it when you hover the mouse over that square. This completes your loop and creates your first mask--i.e. once you finish the loop, you should be able to click and drag that character with the arrow tool anywhere you want.
d. Go down to your composition menu (bottom left part of the screen). You should see your clip there and, under it, the word "Masks" with an arrow to the left of the word. Click on the arrow to expand "Masks." The "Mask 1" listed there is what you just made--yea! It should have a few properties of its own--path, feather, opacity, and expansion.
e. Click on the little stopwatch icon to the left of "Mask Path." A little yellow diamond should appear in the far left. This means you've keyframed (or saved) the position of all of the squares and arrows, basically the shape of the path, for that frame. This is
very important to remember to do or you'll lose all of your work making that mask! (Don't ask me how I know this
) Once you've turned keyframes on with the stopwatch, though, you're set--no need to touch that button ever again.
f. Move the frames forward until you hit the next "extreme" position of the character's movement. (it might be helpful to select "None" instead of "Add" in the drop-down menu next to "Mask 1" to do this) Move your squares and arrows around again so that they outline the character's new silhouette. You might need the "Convert vertex" tool to make the arrows show up again, this is the little angle symbol-looking thingie in the Pen Tool menu. If you do need this, click and drag on the square, don't just click (if you do just click, click again and the weird thing that happens to your arrows will snap back to the way it should be)
g. Scroll between the two poses--AE will automatically create in-between movements for the silhouette. You'll want to do some proofing on this to make sure they're following correctly, but it's a
heck of a lot less work than re-drawing that silhouette every frame.
h. Once you're happy with your mask, change it back to "Add" instead of "None" so all you can see is your character over a black background. Woot! You can now use this to layer in a new composition or etc. One thing you'll probably want to do to make it blend well in its new home is adjust the "Mask Feather" property down under "Mask Path" where you made all of these keyframes. "Mask Feather" will create a little bit of fuzziness around your silhouette so the line isn't quite so severe. How much feather you want is really up to your project, but something like 5 pixels will help almost everyone.
Part 2. The camera seems to be stationary on most of the characters here. If you have shots like that (I'm thinking dance movies might be really good for this) where the camera doesn't move, and you have even one frame of the background without the character, you might be in extra special luck because you can use a Difference Matte. Relatively still backgrounds are best for this, but even something fairly homogenous like clouds could help you out. (if it's a busy cafe scene or something, you're probably out of luck and should go back to part 1)
a. Get that background frame as a still image and make it a separate layer. This is like your green screen. Name it something so you can tell it apart from the clip as a whole.
b. Turn the visibility off on your still image layer (unclick the eye that appears to the left of the layer name in the composition menu).
c. Click on your clip. Go to the "Effects" menu and choose "Keying" and then "Difference Matte." The effect controls for the difference matte should pop up in the menu to the left of the composition screen (above the composition menu). For "View" select "Final Output" and for "Difference Layer" select your background layer.
d. I sometimes put a bright solid color layer on the bottom of the composition to help me see where the mask is working and where it isn't. Play around with the "Matching Tolerance" property in the effect controls until you get something you're happy with--increasingly the percentage means the match between the background and your clip has to be *less* exact for AE to get rid of those pixels. This sounds confusing but makes sense when you look at it.
e. With this technique, it's sometimes a good idea to make a very basic mask (as in Part 1) around your character anyway. This doesn't get close to their outline but follows them in a basic way, so that if anything random pops up in the background (a large bird flies by your clouds, say) you don't end up with that as well.
Okay, I hope that's helpful! Lemme know if anything's unclear or if I should back up here and explain more or etc.!
I don't have any super good suggestions for the second part of your question (about the image degradation) since my guess is that they're filming with a super high image resolution camera. You could probably make a similar effect by taking shots where the camera is already moving like that, or by "zooming out" yourself by making the images small at the start and then gradually increasing them to their original size.
Whew! Sorry for being so long-winded!