Terrorist groups don't do well in stable, prosperous nations.

take the winds out of their sails by letting the Palestinians have a real government with real control over itself

Now that's the kinda hope I was looking for! Can't see Israel going for that, but that's a solid solution. Devil and details and all, but a prosperous Palestine would suck for the terrorists.

But keep in mind, the Arab world does not want a prosperous Palestine. For exactly the reasons you stated.