While the C standard does say that integer promotion happens, if the result is being cast back to char again, a C compiler will see that it doesn't need to operate on 16 bits and is allowed to optimize the result back to 8 bit operations. See for example: https://godbolt.org/z/zM8reeqrc
I feel like 16-bit MCs aren't popular because they aren't popular.
They offer a straight-up 2x performance increase in most applications and something like a 4-10x performance increase with 32-bit numbers (not to mention the space savings from fewer instructions).
Despite this, the 16-bit MCs all seem to be rather niche. I'd love for an open RISC-V variant that could fill this gap and allow sourcing of the same ISA from multiple companies.
As a hobbyist, I use AVR mostly because it is 5V-capable and electrically robust, so it can interface with vintage peripherals without requiring signal-level converters or additional ESD protection. It would be nice to see more competition in this space, for sure.