The producer/director behind the Mario Kart series explains how and why the Blue Shell was put in the game. It turns out the Blue Shell had 2 purposes with one being a hidden purpose.
Gameplay-wise, the shell is meant to keep every race fun for everyone playing. The idea was to keep people playing and not give up due to 1-2 people dominating every race.
Technical-wise, it was meant to keep the N64 processor from overloading with everyone on the screen. The shell in this case was meant to knock people off the track to ease the CPU workload.
The team had the idea to get rid of the Blue Shell for the Wii version of Mario Kart but by then it became too famous and well-known part of the series to just get rid of.
http://kotaku.com/#!5780082/the-make...the-blue-shell