By Paul Tait

BAGHDAD (Reuters) - Years of economic policy mistakes after the fall of Saddam Hussein left unemployed young Iraqis easy targets for recruitment by al Qaeda and other insurgents, a U.S. Defence Department official said on Sunday.

Paul Brinkley, deputy under-secretary of Defence for business transformation in Iraq, said Iraq's shattered industrial base had to be revitalised to bring down unemployment levels of about 60 percent and help reconciliation.

He said political, social and economic stability would be much easier if factories, many left idle since the 2003 invasion to topple Saddam, could win even a small fraction of the trade the United States conducts every year with economies like China, India, Indonesia and Thailand.

"If we could just get some of that factored into Iraq we'd uplift the lives of every Iraqi and al Qaeda wouldn't have any people to recruit," Brinkley told Reuters in an interview.

Brinkley said early economic planners had made the understandable mistake of assuming that a free market would rapidly emerge to replace what he described as Saddam's "kleptocracy", and create full employment.

This mistaken assumption led to a series of decisions which "sowed the seeds of economic malaise and fuelled insurgent sympathies" after industrial production collapsed and imports flooded in to replace locally made goods.

The Coalition Provisional Authority, headed by American Paul Bremer, was set up by the western allies after the fall of Saddam and largely ran Iraq until June 2004 when an interim Iraqi government took over.

Brinkley said unemployment and under-employment of the proportions in Iraq would create unrest in any country. In a recent Military Review article he said Iraq's unrelenting violence "is in no small part a result of economic distress".

Increased industrial output creating more jobs would help Iraq achieve the reconciliation between the warring Shi'ite majority and the Sunni Arab minority dominant under Saddam that politicians have so far been unable to bring about.

"The job of political reconciliation is infinitely simplified when you have people trading with each other," said Brinkley, who heads a task force, formed in late 2006, which works closely with the U.S military in Iraq.

TRADING AMONG THEMSELVES

Current policy needed to reflect pre-2003 conditions, when more than a decade of U.N. sanctions on Iraqi products had the indirect effect of leaving Iraq's Shi'ites, Sunni Arabs and Kurds with no choice but to trade among themselves.

Brinkley's task force is now assessing factories across Iraq's industrial base, from textiles to petrochemical industries, engineering and agriculture, to find suitable candidates for micro-financing grants.

"These factories used to sell to each other. They couldn't export, so Sunni, Shi'ite and Kurd traded with each. They haven't done that for several years," he said.

Nine factories, from among 65 assessed by Brinkley's task force, have already received funds from $50 million designated this year by the U.S. Congress for industrial revitalisation.

Brinkley said the $50 million was about $150 million short of what some estimates said would be needed but the U.S. and Iraqi governments would likely be easily persuaded to contribute more if early successes were made.

Iraq's deputy industry minister, Sami Al-Araji, said his department was working on a plan to have a small number of Iraqi textile products like men's suits in U.S. department stores by Thanksgiving or Christmas this year.

"We thought we'll start modestly," Araji told a news conference. "You could call it a public relations campaign."