How does increase in water cement ratio decrease the permeability of concrete?

Increase in w/c ratio from 0.4 to 0.7, increases the permeability by nearly four orders of magnitude i.e. from 10^(-12) cm/s to 10^(-8) cm/s.*

This is because of two primary reasons:
1. Formation of high capillary porosity from large and well-connected pores. 
2. Increase in micro cracks at the interfacial transition zone between aggregate and cement paste that are induced by drying shrinkage (which is again directly linked with the w/c ratio). The diagrammatic representation of interfacial transition zone between aggregate and cement paste is shown below.

(Image credit: Concrete, Microstructure and Properties by Mehta and Monteiro.)

All said and done, concrete is batshit crazy material. Its behaviour is not understood completely by us. We can only improve our knowledge based on new empirical observations and findings.

*Values for hardened cement paste only.
*Data source: Powers, T.C., J. Am. Ceram. Soc. ,Vol. 4, No. 1, pp. 1–5, 1958.