If we're talking the Middle Ages, banking was very very limited.
Similarly, in the Middle Ages there were no dragons or channellers, the world hadn't just suffered an apocalyptic event that left all lands infertile save those which the few survivors capable of channeling magic could invest their magical essence in to revive, and, most importantly, there was no semblance (or acceptance) of anything resembling magic. My point is that there are means available to the denizens of the Elemental world not available to the average medieval peasant or merchant.
Transport networks were too poor to support any significant free market: early experiments in removing tariffs and restrictions on movement and sale of goods, for example, lead to hoarding, famine and rioting.
I hope that transportation networks will be improved from the historically-accurate norm to the point of feasibility for this game, since the complete inability to move large quantities of goods from one city to another with relatively high frequency (which I think is what you're getting at as one of the free-market requirements that are missing) would probably be annoying to most people, and, at least in my opinion, not contribute enough strategic value to be worth it.
Most trades happened outside what would today be the taxable economy, through barter and obligation rather than currency. The fundamental unit of wealth was not skill or ability to labour, but ownership of land.
I'm also fairly sure that Stardock won't end up implementing a barter-based economy. At least I hope so; I'd hate to have to negotiate the cost of building my new fort in terms of fish heads and beads.
And since we can assume the existence of fixed currency and decent transportation, I see no reason why something like the 'free market' idea should be vetoed on grounds of gameworld consistency.
So I think the flavour would be wrong. In terms of the game mechanic, I would welcome efforts to avoid spending increasing amounts of time on colony management as the game goes on.
I, too, would like to avoid spending increasing amounts of time on colony management. I always hated the late game economic management even in games like MoO2 and MoM, not to mention games like Space Empires IV/V and their absurd complexity. However, I personally wouldn't feel that the 'flavor' of said free market system would be wrong. I actually think it would be really cool (granted, of course, a competent enough AI market).
As for the effectiveness of late colonies, I think I'd prefer for the settlement phase to end somehow.
I'm pretty sure that the devs mentioned somewhere that the game was designed so as not to become a patchwork quilt of cities in the late game - which probably means slower settlement that goes on for longer, FWIW.