Unfortunately, I think you're seriously wrong about that and it was one of the main issues I pondered over when I first played MTW. The faction AIs do indeed seem to act as seperate entities, but there seems to be an overriding AI governing the game in a certain direction for the benefit of the human player. I've always thought this is one of the reasons they've skirted around the prospect of a multi-player version of the campaign game. As long as it is not designed to be multi-player, balancing the relative strength of different factions on the campaign map is unnecessary. It allows the game developers to take liberties to impose situations on the human player. For instance, it would be simple for ANY bordering faction to simply crush the Polish faction in MTW early in the game. But they don't. Otherwise, it wouldn't make much sense to try to play the Polish as a human player, right? So this AI "overseer" makes sure that doesn't happen. I think we get a small glimpse of him through the Pope and the Senate, wherein he tries to direct your actions as well.

After you reach a certain skill level in the campaign game, the AI is never really that challenging, but what it can do (if you allow or encourage it to) is set up some really interesting scenarios.