"Living in W'ales" by Richard Hughes, 1931
After some searching around Google Books and the internet in general, I believe it's the above short children's story, first published in The Spider's Palace and Other Stories. The best synopsis I can find is from this blog post (emphasis mine):
In the first story, “Living in W’ales,” “Once there was a man who said he didn’t like the sort of houses people lived in, so he built a model village. It was not really like a model village at all, because the houses were all big enough for real people to live in, and he went about telling people to come and Live in W’ales.” This man becomes a pied piper, leading everyone away to W’ales, including a little girl and a dog who get lost along the way and, seeing a whale, ask to be allowed to live in it.
Here is a quote from the story itself (found through Google Books):
So they went along till they came to the sea; and in the sea was a whale. The litde [sic] girl said, "That was what he meant, I suppose, when he talked about living in Wales [sic]. [...]"
(Both instances of [sic] indicate potential OCR errors, as I haven't been able to read these sentences off the actual pages, but only from Google's transcribed search results.)
From the little information I can find about the book it's not clear whether the story actually has anything to do with Wales, though.
The story also appeared in Fun in Bed for Children: First Aid in Getting Well Cheerfully by Virginia Kirkus and Frank Scully, published in 1935, which is where I first found it, and again in The Wonder Dog: The Collected Children's Stories Of Richard Hughes, published in 1977.