Will it look better than a blu-ray? No. Can it be equal? Pretty darn close, I think. The upscaling makes for a very sharp picture, I feel. You would have to take a look for yourself to see how you feel about it.
As for the 720p/ 1080i question, I prefer the look of 720p although the sharpness is about equal overall due to the interlacing of the picture cutting things back a bit. Both Blu-Ray and DVd will look good at either res.
Jay, you can't really compare the upscaling on the PS3 to what the PS2 did for PSOne games. This isn't just a bit of texture smoothing in software here- this is the system pumping out the signal in full hi-def for everything from PSOne games to Blu-Ray. They are two completely different processes.