One of the most puzzling aspects of Israeli policy over the last five years is that neither the Sharon nor the Olmert governments have given the Saudi peace initiative any serious consideration. For most of its existence, Israel could only dream of an offer that explicitly includes peace, recognition of Israel's right to exist and normalization of its relationship with the Arab world. Why, then, has Prime Minister Ehud Olmert offered nothing but lip service to the Saudi initiative, and why did former prime minister Ariel Sharon never even indicate that he took it seriously at all?
There are good reasons to believe that the Saudi initiative, ratified by the Arab League, stems from solid and tangible interests on the Arab side. The Saudis and other regimes in the area are afraid that the Middle East could disintegrate into chaotic disarray if the tide of sectarianism and the surge of Islamist movements are not hemmed in. They believe that the Israeli-Palestinian conflict is one of the most powerful destabilizing factors in the area, and they have good reasons to think that it fuels Islamic extremism. The Arab world has come to a point where it is joining the international legitimizing of Israel provided by the 1947 UN resolution that endorsed the partition plan, because it no longer believes that it is in its interest to reject Israel's existence.
Why, then, does Israel not engage with the Saudi peace initiative? This initiative, like any Arab proposal that will ever come up, demands a "just solution of the refugee problem." The deep-seated fear in Israel is that the Arab insistence on a solution for the Palestinian refugee problem is ultimately a ploy to wipe Israel as a Jewish state off the map, not through military means, but through demographic means, by flooding Israel with millions of Palestinians.
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Here, I believe, resides the deepest reason for Israel's reluctance to actively engage with the Saudi initiative. Israeli public discourse and national consciousness have never come to terms with the idea, accepted by historians of all venues today, that Israel actively drove 750,000 Palestinians from their homes in 1947/8 and hence has at least partial responsibility for the Palestinian Nakba.
http://www.haaretz.com/hasen/spages/868469.html