As for the Radiant AI in Oblivion, yes they had a working form of this. However, in testing they found out that their radiant AI behaved like -ahem- real people, meaning that people would steal things from their -cough- neighbour. Or just borrow them, and when people came back for their things, say a rake, or a thingie, when the other people wouldn't give it back, an argument, and then a fight, and I do mean a real physical fight
would start. An npcs would kill each other, the guards would react, and suddenly entire cities would not be -ahem- alive another.
As for npcs being allowed to go on with their daily lives, Gothic 1 did this, as well as I think, one of the Ultimas, Ultima 4 or Ultima 7, or maybe both did this?
I agree that the game The Witcher 2, looks amazing. I think, maybe partly this is due to the fact that CD Project decided to make their own game engine so they could design the game as they wanted it to be designed (made). Partly also, because CD Project RED is basically a huge company (they publish games as well, and have a lot of other incomes than just making games) which means that they can take their time making good games.