I understand that Small creatures have the space and reach of Mediums so that Sam and Frodo aren't outright gimped in melee. But from an internally-consistent and a realistic PoV, it's absurd that they all seem to have chimpanzee arms. It makes those Small penalties mere tokens, lip-service to realism, in a game that has never been overly concerned with realism. 3.x and 4e effectively have one PC size category: Smedium.
Melee reach and space have never been about the size of your arms, though.
(Even in 1e, it was about the length of your weapons, anyway.)