Your fallacy is thinking that more soldiers automatically brings all the poor mechanics from the original game with it. Having more soldiers does not have to mean that everyone has squad sight, for example. Having more soldiers also does not have to mean the devs would have to be incapable of creating total party kills.
And here I thought timewatch was trying to do just the opposite.
You're right that they're not naturally linked, but I've seen you make the argument about big squads being "able to impose their will on the battlefield with impunity" several times. Doesn't it fall in the same category?
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The argument timewatch puts forth (as I understand it) is basically this (yes, I made it with paint and it doesn't even attempt to have correct proportions etc):
http://img706.imageshack.us/img706/3...msoldiers2.jpg
When the first soldier dies, the squad won't have as much strength anymore so the next soldier is likely to die faster than the first. The time the first soldier dies is assumed to happen earlier when there are more units on the map (including enemies). Total strength of the squad over the duration of the mission (in other words, difficulty) is represented by the area of the bars.
I don't actually agree with this as the shape such graphs take is entirely dependant on the balancing of the game. They can be made to favour either option depending on the expected average time of first death.
If that's not what you meant timewatch, apologies.
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tl;dr - Squad size for a game still in development does not have to have anything to do with difficulty. Difficulty is a balancing decision and devs were either unable or unwilling to balance the game around a bigger squad. Increasing squad size after the balancing has already been done (ie. after the game is released/not considering possible mods) will in all probability make the game easier, while decreasing your squad size will make things harder.