Two comments:
1. Yes, they will scale... Android does that automatically... it's actually NOT scaling that requires additional software implementation and is a pretty trivial hack.
2. You're wrong about the iPad, it runs iPod/iPhone apps BOTH in 480 x 320 OR in the iPad's native resolution, full screen. The iPad has, built in, a degree of antialiasing and dithering to make the pixels not too blockish when blown up, however, without optimizations/updates by developers, it will just be the literal 3.5" app blown up to 9.7"... however there is no "tiny window" problem as you present it.
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