How can Google tell if a link is paid for or one just recommend by the site?
Do not underestimate the Google algo :-)

The basic linkspam spotting (paid or not) is actually quite simple.

1) There are many bigger linknetworks and all have a custom scripts to implement links (and this can be detected).

2) Then there are known networks selling links and these can be dealt with manually (downgrade or filter the links from these networks).

3) A sitewide link in the footer or sidebar is a typical (not always) place for a bought link and this can be detected.

4) Most directory links are paid links and can be detected

5) And much more

I recently tested this and bought 1 000 links to a page I manage from more or less the top paid directories. The links were gradually addded, had different link text etc. to avoid a penalty or filter. The site got no filter or penalty for this, but nor did it gain anything when it comes to SEO.

I know this is only one example, but I have been doing SEO since 1998 and as I see it one big trend that has been around for a while is that the SE algos are getting smarter and the on page optimization is loosing its importance.

And for those of you who buy links do not look at the Toolbar PR it says nothing. A site can have a toolbar PR of 10 and have no traffic from SEs because its banned. Such site passes no PR to your site.

And finally much more important than PR is TrustRank.