An Israeli friend of mine wrote this:

Mistake #1:
Education. Israel’s bureaucrats, over the years, allowed for the creation of three different education systems in Israel - one for Israelis, one for religious Jews and one for Arabs. The first is controlled by the state (and not doing so well) while the other two are only supposedly controlled by the state (and doing significantly worse).

Mistake #2
Erosion of the authority of the state. From ‘48, Israel has allowed various groups autonomy in the Ottoman tradition (also explains some of the reasons for mistake#1). The consequences are varied and usually negative, and I have to give a breakdown of some of them for a more complete understanding of the issue:

Mistake #2.1:
Arab lack of respect for the law. Arabs in Israel have, for instance, much higher numbers of dead and wounded from car accidents because they disregard the laws of traffic: ignoring red lights, not putting on seatbelts, driving without a license, stuff like that. Like with all small crimes, it leads to big ones - Arab settlements are choking in Arab crime but do not cooperate with the police. It also leads to all kinds of other things, like illegal construction (usually built on land they do not own, without permits, without planning and ignoring safety measures) that leads to great difficulty in providing infrastructure, increase in road and domestic accidents and occasional house collapses. I am not even talking about them seeing themselves as a 5th column striving to destroy Israel and kill all the Jews, although unfortunately they do.

Mistake #2.2:
Jewish lack of respect for the law. This is a much smaller problem, a part of which has incredible global media exposure. Specifically, I am talking about Hilltop Youth - people who, like the Arabs, build illegally on land they don’t own. A few thousand of these people are now living in illegal settlements throughout Yehuda and Shomron, where law holds little sway. As you can imagine, they are troublemakers - but fortunately the trouble they cause is usually restricted to their own community and neighbours. Occasionally the Jewish lack of respect for the law produces a nutcase like Yigal Amir (Rabin’s assassin) or Baruch Goldstein (mass-murdering terrorist), both of whom are a product of autonomous groups within Israel that disrespect and disregard our laws.

Mistake #2.3:
Ultra-Orthodox lack of respect for the law. To the best of my knowledge this problem doesn’t get any international coverage, but it is very much like Mistake#2.1 - sick communities stewing in their own self-inflicted misery, disdaining the state and using a combination of violence and political pressure to force their theocratic wishes upon it. The most famous one is the Mea Sha’arim neighbourhood in Jerusalem - any non-ultra-Orthodox person entering it is likely to be assaulted. They have managed to get representation without taxation, holding the rest of Israel by the short and curlies. This also ties in into relevant problems of the Israeli electoral system, in which a small and unprincipled group can force the majority to unspeakable idiocies.

Mistake #3:
Hubris and misplaced mercy in the wake of Six Days War. In that war we took back our Kraj Sudetów, namely Yehuda, Shomron and East Jerusalem. Rather than expelling the hostile population as any other state has done in a similar situation (victory in a war of genocide started by the other side), Israel chose to let them stay. In doing so, we became suddenly responsible for a hostile and primitive population that values our deaths more than their own lives. A monumental mistake. That was the misplaced mercy. The hubris was that Israel’s leaders at the time really thought that if we gave them electricity, running water, closed sewers, roads, literacy and other trappings of civilization they’d stop trying to genocide us (the reason they started the war in the first place).

There’re plenty of other mistakes, but these three are the really important ones.

As for Jerusalem... when the Arabs took half of the city, they destroyed every Synagogue, used Jewish tombstones to build latrines and everything else their comrades in goals did to Jewish places in Germany during the 30s and the 40s. Jerusalem was the heart and soul of the Jewish people for 3000 years, from the time King David conquered it from the Jebusites, fortified it and declared it his capital. It IS the eternal and undivided capital of all Jews and has been since that time, whether it was held by one enemy or another. It’s not even about religion - I am as secular as they come and even I understand Jerusalem. It has been in the thoughts of every Jew for three millennia; every stone on its hills is soaked in Jewish blood, sweat and tears. Giving it away is giving away our heart and soul. Dividing it and giving a part of it to enemies who’ll despoil it is unthinkable. It will not happen.