It was a great idea to make the PS3 completely backwards compatible with all of the previous PS One and PS2 games. Even though almost every game works, Sony didn’t do its job really well because they look worse on the PS3 than the PS2.
At this point all Playstation 3s have an extra chip in them to take care of older games which is actually nothing more than a shrunk-down version of a Playstation 2. The video output is still done by the RSX graphics chip on the PS3 and according to this forum thread the problem might be in there. Sony will probably remove the PS2 chip in a later revision of the console and let the PS3’s Cell do all the work. So why do previous gen games look worse? We don’t really know for sure, but we do know that the examples shown in the video below look pretty ugly.
According to the video the PS3 resized the graphic output of PS1/PS2 games at a low resolution with no filtering causing artifacts and amplifying jagged edges. We also know that it’s nothing cable related, even with a high-end HDMI cable, which is the best way to send the signal to your tv, the games still look crappy. Some people have found out that games supporting progressive scan (480P) don’t suffer as much, and you can limit your problems by turning it on in the dashboard. The video also says Sony knows about these issues but they refuse to do anything about it because most people won’t care too much, but we can’t confirm that statement. The image below shows the difference between 480i and 480P on the PS3.
If you’re an early adopter and really care about your older games, you’d best keep your PS2 and PS1 around for a little while longer. Once the PS1/PS2 emulator is finished, these problems will probably be over and you can hopefully play your games in an even higher resolution where everything’s sharper instead of crappier.