Engine development for manufacturers who are lagging behind should be unlimited until they're within whatever percentage of the best. That obviously comes with complications (given it's not just power, there's fuel efficiency, size, heat, etc, which had to be considered), but it could work with a well designed system of rules around it.
It couldn't work at all, not even in the slightest. Engine development takes absolutely months, it's not a case of hey lets try this new shape on a nose, it's hugely more involved for even a small piece and manufacturing turn around alone on engine pieces is far far longer then requires massive testing and iterative design to get to something you want out on track.
By your process an engine that was way behind could go off, come back a year later with an engine 10% faster than everyone else and only at that point would other people be allowed to develop and it would take them a year to catch up.
With the rules as they are there is plenty of scope to catch up, Honda just went with entirely the wrong engine design to start with. Ferrari did for 2014 and fixed it for a year later, another year of improvements and they'll close in on Mercedes again.
People also need to get a freaking grip, 95% of engine development is done in the lab and on complex dynos. There is very little to be gained by more track testing, an engine won't realistically be ready to go out on track to be tested in the car till it's gone through a bunch of iterations and thousands of miles of testing in a lab, by which point track testing proves the piece, not improves or changes the design. Testing of the engine in the lab is unlimited already.
Currently the tokens allowed Ferrari to entirely change the engine between the two seasons and fix a monumental layout mistake. Reliability changes allow effectively unlimited changes for reliability reasons, testing on dynos is more than good enough to develop an engine and is entirely unlimited. Track testing is for proving your parts work together and getting the package working as a whole. The preseason testing we've had has proven it's enough. The worst car in terms of package of decent pieces was RBR last year and they went from awful testing to fixing the packaging(mostly electronics and cooling for the engine) by the first race because they learned enough from testing. It was clearly more than enough for Merc/Ferrari.
The only team it wasn't 'enough' for was Mclaren, because between Mclaren and Honda they made a **** car with a **** engine that was going to take a year to fix regardless. Unlimited testing this year would have made absolutely no difference to Mclaren at all just cost them a load in extra engines that died.
Look at Renault, they have reliability issues and are free to improve them, and tokens to improve performance and it's still not going to have updates ready till Sochi(at the earliest), engine development takes a long time and if you start the season with a terrible one that is what you're stuck with. Complex engines take a long time to develop, currently have unlimited testing but are limited to the people designing the engine. The rules allow a huge amount of changes and more than enough testing for the engine side of the car.
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