My wall of text died. So...repaired wall of text!
Regarding the Living World
I say yes, yes, a thousand times yes! Heroes of Annihilated Empires was, by all rights, a letdown of a game (if you want to see what rushing a product looks like, look ye to HoAE) but I still frequently play the skirmish mode. While my allies are building up bases (you can play it as an RTS or have your hero level and function like an RPG) I would have a blast hiring as many goblin/gnoll/orc tribes to fight under my banner. Couldn't control them physically, but they raided my enemy frequently on their own.
Just seeing Elemental go with the basic "Hire troops", "Leave alone" and "kill lair-dwellers" would be a letdown. I personally want to see at least some level of basic interaction between lairs. There is no way I would expect you to have something like...Gurkesh the orc champion killed Borgash the troll king 20 years ago and the trolls have been secretly planning revenge to the point of building up a massive army and are preparing to strike out across your lands while the orcs have heard of this from Gibblegob the goblin and your capital city will be where both factions converge.
What I would expect is basic interaction. Give a basic need (food?) and when that need is not met for whatever reasons, the lair dwellers go on their way. From here, let the possibilities flow - let them perhaps migrate to another lair, or take over another, or what have you. Just something more than "we will wait here until we are recruited or attacked" will be sufficient. Perhaps give a chance on encountering another faction to go to war, leave peacefully, or form an alliance of sorts (they work together, no more than that)
Why have this? Simple. The options that a player could have for their individuals games would be massive. One game could see two lairs fighting each other next to your territory, another could see them become allies. Perhaps you wipe them both out, or just the enemy of one and become allies with another...something different.
It will offer up something else, too. This is a new world, and my Sovereign has the option to restore the land and become a figure of hope and power. So can other Sovereigns. Restoring the world should have an effect beyond making those other Sovereigns want to kill me. I mean, if I am a beacon of hope to a hopeless world, I'd like that hopeless world to look at my Sovereign and act accordingly. I want to play a game and have some random lair-dweller come up to my soldiers peacefully and say, "We want to live in peace on your lands" and then have another one try to destroy me. I want to fight against more than just other players, not just sit there and let things go about because I made them. This is a WORLD that I am going to be altering. The world should react accordingly.
Regarding the Economic System
I'll be perfectly honest here - the thought of having to build up X iron, to turn into X/2 iron bars, to turn into [(X/2)*.03]/Z iron swords would really irk me. First, it seems needlessly complicated. Second, I am a physics major in school - I do my computations for work...in school. I have no intention whatsoever to have to keep a calculator nearby when I am preparing to build an army.
So, I like the idea of just being direct.
Regarding Tactical Combat
I've played various games, some TBS some RTS. I've played Age of Wonders, I've played Total War. I've played Sins and Gal Civ II.
RTS does look...better. It's more entertaining to watch, because you're watching actual combat rather than what seems to be a few pieces moving across a board. I had hoped to be able to sit back and watch battles like the Lord of the Rings unfold before my eyes, see fireballs and lightning bolts and ice storms and lava maim and kill my enemies. To watch troops advance towards each other, arches letting loose, magic filling the air with metaphysical death...everything. Furthermore, it's viable to have tactics and strategy in an RTS. If I arrange my soldiers in columns or rows, they act based on that. Soldiers will advance as a whole, with my infantry up front, ranged at back.
I do not want to have a game where horsemen kill my archers because they literally ran past my infantry. Nor do I like the whole "soldier one moves...soldier two moves...soldier three moves...soldier four moves...end turn. Soldier one moves...soldier two attacks...soldier three attacks...end turn." That is...
Look. When I first was reading about Elemental, I read something to the effect of "You can control your own soldiers. As your champions/heroes gain levels and become good leaders, you can trust in them to lead battle for you." I want to sit back and watch battles sometimes. Furthermore, I don't want to spend my playing time leading each individual unit - I'm playing a mighty sorcerer, not a general. I like battles...but sometimes, it's more fun to watch and just act when it suits you.
To that end, I think that it'd be best to go with the whole "both sides give orders, units react" thing. This could have numerous advantages! First, there is no need to worry about reaction time - you and your opponent both 'move' at the same time. There is strategy - predicting your opponent's move and countering it, reacting to their moves. Everything happens at once, so there's no need to put a line of troops surrounding each archer just to prevent a horsemen from racing around an infantry or two and take out my prized wizard, thus erasing my whole magical defense.
The battles could be cinematic, too - just take out the actual strategy phase and replay a battle to your heart's content. It might be a little choppy, but it's still something.
Regarding Hexes/Squares
Whatever works for you, Brad. I'm sure it'll be fine.