I believe your thoughts are ... on target.
Yes, covering up toddlers is likely to increase the likelihood that people start thinking of them sexually. This is not exactly a secret.
And yes, around the world young girls with flat chests frequently (but not always, and less now than in the past) go topless at the beach. It's pretty much just the U.S. that makes a big deal about covering them up.
But that's not all - in most of the world it is not unknown for young girls to be entirely naked in public. This is especially true for short times, such as when they are changing into or out of a swimsuit, or squatting to piss over a sewer grate. (The latter is more common than you might think.) Though not at all common, I've even seen a pair of young sisters not wearing a stitch of clothing and mingling with a crowd on a major public beach in one of the English-speaking countries that is as anti-pedophile as the United States ... and no one said a thing or even looked at them funny.
The United States really is unique in its level of prudery. Even Muslim countries are typically not so extreme.
As for Target, the store - I'd say it is a win that they had this commercial. It's a subtle way of reminding people that this is normal.
But while I do not plan on boycotting Target, I'm not going out of my way to shop there either. Perhaps they are on the right path, perhaps not - but for the moment at least they do not seem to be actively opposed to us.