Thanks Amamake.
I played for about an hour this morning and found things to be much easier. I saw the guy in the observatory and realised that I could do quite a lot in Arlania without actually fighting anyone. I was able to get the dirigible's black box, dragon's tooth and shipwrecked cargo quests by running away from enemies.

In fact there is so much bounty lying around in Arlania that I was able to rack up about 20,000 with no trouble.
The problem, as I said before, that as a Paladin you don't have any offensive spells or ragebox early in the game. Chaos Magic is quite hard to get to as a Paladin, which means I am relying on Pain Mirror to inflict damage from a distance. But it's all good now, off I go to get the ragebox.
I found that the Scouting skill is VERY important on Hard. And it needs upgrading too. It's not enough to say that there are 'lots' of enemies.