In the four months since hawkish Prime Minister Benjamin Netanyahu came to power, West Bank Palestinians have enjoyed an economic recovery and Israel has experienced a period of relative calm.
That progress is the backdrop for a fresh round of U.S. diplomacy aimed at getting Palestinian-Israeli peace talks started again.
But there is a major sticking point. Palestinians are refusing to resume negotiations unless Netanyahu heeds the U.S. demand to stop all construction in Israeli settlements on lands they claim for their future state.
Netanyahu grudgingly accepted the idea of Palestinian statehood last month only under heavy U.S. pressure and with conditions attached. And he is still balking at President Barack Obama's demand to stop building Jewish settlements.
But on the ground, the Israeli leader is pursuing his own idea of how to best achieve lasting calm. His so-called "economic peace" aims to create the conditions for a settlement by building up the West Bank's economy.
He has focused only on the West Bank, the Palestinian territory run by a moderate leadership, as opposed to Gaza which is controlled by the rival government of the militant Hamas.
Netanyahu 'off to a good start'
Netanyahu's plan has gotten off to a pretty good start. In the West Bank, military checkpoints have been lifted, permits for importing raw materials are being granted. Shopping centers and movie theaters are popping up and concerts and sporting events are other signs that life there is taking on a semblance of normality.
The International Monetary Fund recently predicted the West Bank economy could grow by 7 percent this year, its first optimistic forecast in three years.
"We are not waiting. We are doing. We are opening roadblocks, we are opening ties, we are opening the roads to peace," Netanyahu said Tuesday while presiding over the extension of trading hours at the crucial Allenby crossing between the West Bank and Jordan.
The Palestinian demand to stop all settlement building before they will resume peace talks is not a condition they placed on Netanyahu's predecessor, Ehud Olmert, who brazenly expanded settlements even as he talked peace.
But two things have changed since Olmert left office: a new administration in Washington has shown less tolerance for settlement activity, and Palestinians are more distrustful of Netanyahu.
Palestinians doubt Israeli leader
Palestinians doubt Netanyahu, who leads a coalition of rightists opposed to territorial compromise, would ever do what it takes to make peace, including uprooting tens of thousands of Jewish settlers to make room for a Palestinian state.
The Israeli leader attached so many conditions to his acceptance of Palestinian independence last month as to render it meaningless in the eyes of many Palestinians.
And some wonder whether his decision to ease Israel's chokehold on the West Bank is more about getting Obama off his back — and deflecting attention away from settlements — than any precursor to historic compromise.
"Netanyahu is offering real and serious improvements in the West Bank, much more than his predecessor Olmert did," said Khalil Shahen, a commentator for the al-Ayyam daily. "The only explanation for this is that Netanyahu is seeking an economic peace rather than the political peace."
The West Bank's economic revival sharply contrasts with the misery of Hamas-controlled Gaza, where an Israeli and Egyptian imposed blockade is stifling most economic activity.
Of all the obstacles to achieving peace, perhaps none is as large as Hamas militants' violent takeover of Gaza two years ago.
But even on that front, there is some improvement. The rockets that Gaza militants had been firing into southern Israel for the past eight years have all but stopped, after a punishing war at the start of the year that killed more than 1,000 Palestinians.
Palestinians savor Obama-Netanyahu tensions
For now, Palestinian leaders seem to be savoring the tensions brewing between the conservative Netanyahu and the liberal Obama — despite historically close ties between Israel and the U.S.
"I don't think that the Palestinians would resume talks with Israel before freezing settlement expansion," said Palestinian government spokesman Ghassan Khatib. "Every time we had the negotiation track beside the settlement expansion track, the settlement track killed the negotiation one."
Israel captured the West Bank, now home to some 2.5 million Palestinians, in 1967. The number of Israeli settlers there has more than doubled since the mid-1990s and now stands at around 300,000, in addition to another 180,000 Israelis living in Jewish neighborhoods built by Israel in east Jerusalem, also captured in 1967. Gaza has about 1.5 million Palestinians.
Hope for a future state
The Palestinians hope to establish a future state in both the West Bank and Gaza.
Israeli leaders say they expect to reach an agreement with Washington over Obama's demand for a settlement freeze. But Netanyahu's public rejection of Washington's demand that it drop plans to build new apartments in east Jerusalem — which the Palestinians claim as a future capital — show that his simmering disputes with Obama are far from over.
A fresh point of contention emerged on Monday on the issue of Iran's nuclear program. Israeli Defense Minister Ehud Barak, standing beside visiting U.S. Defense Secretary Robert Gates, suggested three times that Israel is not ruling out military action against Iran, despite Washington's clear preference to keep the focus on diplomacy.
Obama's top Mideast envoy, George Mitchell, wrapped up a new swing through the area on Tuesday, announcing "progress" in his attempts to resolve the settlement dispute but with no word of a breakthrough.
Obama's attempts to persuade Arab nations to begin normalizing relations with Israel, perhaps by opening up trade offices, could make it easier for Israel to compromise.
Bahrain's crown prince, Shaikh Salman bin Hamad al-Khalifa, wrote an unusually conciliatory op-ed piece in the Washington Post calling on Arabs to engage the Jewish state. Mitchell met with the crown prince Tuesday in Bahrain and praised his initiative, the official news agency reported.
But Saudi Arabia — the country whose participation most matters to Israel — is refusing to heed Obama's call.