Yes, smaller races are significantly disadvantaged as melee combatants. If not just for the limited carrying capacity and the slow speed, but the pitiful damage that smaller weapons deal.
Actually, the only valid complaint there is slower speed. Small characters actually have MORE carrying capacity per Strength than Medium characters, and the difference between a medium sized weapon and a small sized weapon is generally 1 point of damage at most, on average. I would gladly trade 1 point of damage to gain +1 hit and +1 AC, most of the time anyway.
As for Half-Elves, I think they're fine, now. They're almost as versatile as Humans, but they still keep some of the nifty Elven traits, too.