PC-Engine, you have made your mind, so there seems to be no point in trying to change that, but I'd just like to address some of your points:
7. No self shadowing not a hardware limitation IMO. Developer decision.
Don't be so sure. There isn't a single DC game (except maybe for JSR, I'm not sure) that has that feature. Shenmue was thriving for realism, and I'm absolutely sure it was not a developer's decision but more a hardware limitation or the lack of time (although they spent years doing it and fine tuning the engine). I know DC could do it in theory, but with complex demo like that it would probably result in FPS being too low, or just not looking good enough. Again, theorizing of what the machine could do means nothing if noone has ever done it.
2. Cutscene with no movable camera or light source.
SH3 has dynamic lights and atually animated objects moving around in the scene. So both camera and light sources are movable.
4. Hair does not animate.
Actually, it does. Look that long heared woman. When she moves her head, her hair animates accordingly, falling on her shoulders. Young girl's hair is also animated, and very finely and realistically. Watch phone scene, for example.
5. LOD is used when camera zooms out to allow two fairly detailed characters in cutscene.
Shenmue does the same thing in it's cut scenes and in-game, but frankly, I don't understand your point here. Of course they are going to use LOD - offline rendered movies use different LOD for characters that are farther away. Why is it wrong using less detail when you wouldn't be able to see the extra detail on the model that is farther away, anyways?
I hate using the rolleyes icon, but this one just screams for it
Again, just compare the actual games. Compare the models, the lighting, the textures, the shadows (not only self shadows, SH3 has what looks like unified lighting model where shadows are being cast on everything) There is no 'catching up' here. SH2 graphics were already more impressive technically then Shenmue, and this simply leaves it in the dust.