Looking at the xml and without giving exact numbers, this is what difficulty seems to impact at least as far as the AI is concerned:
AI Economy (I'm guessing income)
Whether or not the AI can see through FOW (again, a guess based on the variable name)
What % of the unit's HP the AI units have (i.e. unit defined HP * this = HP the unit has if AI owned)
A couple things involving sovereigns. One involves their HP (I'm guessing just like with the units above). The other - I have no idea. It seems like some kind of way where the AI can make custom sovereigns, but I don't think I've ever seen the AI do that?
The intelligence of the AI (probably what strategies/builds/etc are enabled)
And whether or not the AI will use tactical spells.
This is probably for the difficulty on the "Pick your foes" screen?
Edit: I did a search on all xml in the data/English directory and that's the only mention of it. I tried searching on "Normal" and found a couple other things, but no way of figuring out anything else. Will keep looking as I can.