To make war profitable, you'll NEED to make each territory taken in war 1/2 the cost to take it in peace exactly (as in war, there's 1 winner, and 2 combatants) - also, an attacker would aim to have at least double the defender's power before trying anything.
One possibility that needs to exist is that a person could stockpile military forces for an invasion. An -im-possibility that needs to exist is that a defender shouldn't be able to wall someone twice their size.
There needs to be a motive for expansion.
When I try to tweak your system it just doesn't allow it because a military response is
immediate, either large nations get elevated to steamroll status with no lasting penalties or smaller nations can wall them.
I'm screwing around with the numbers to see if I can come up with something linear but also intuitive. Obviously armies need a high 'creation cost' and minimal maintenance cost from there. A Constant ability to take territory seems good for removing most of the exponentials associated, and military power proportional to # of territories also works, but I don't want to do this with any Gold (or whatever economy resource) carrying over between turns.
Annoyingly, giving the players the option of supporting different sizes of military massively increases the Action Point total, and not giving them that option goes against the general idea of an economy+war game. Balancing, balancing.
There's the issue of massive breakpoints in an action-point system, too - in an economy system, any gold unused carries over. With action points it's wasted, and it'll be wasted very goddamn often with anything but aspergers-level micromanagement.
armies need a high 'creation cost' and minimal maintenance cost from there.
And that, in itself, leads to massive militarization because nobody will want to disband their armies, even in peacetime. Perhaps there could be a Buyback of 75% of the army's initial cost to disband it? :S
It'd certainly lead to natural steamrolling tendencies - buy up armies, declare war, win with armies, use disbanded funds from armies to grob londs, ride the exponential curve for a bit then repeat.
Right, econ system is go. But it needs to be SIMPLIFIED. ... LOTS.
I can probably do that, but it'll take some time getting everything in order :]