BETHLEHEM (Reuters) -- Three generations of Palestinians displaced by the founding of Israel in 1948 know only life in UN refugee camps, going to schools beneath the blue-and-white UN flag and drawing their food stocks from UN warehouses.

For these Palestinians whose long-cherished goal is the right of return to the lands they lost 64 years ago, the camps must be seen as temporary no matter how permanent they might seem to others.

Which explains why the latest program by the UN Relief and Works Agency for Palestine Refugees, or UNRWA, to upgrade the camps' dilapidated facilities is such a delicate operation.

The United Nations and other agencies have been providing essential services in the camps for decades without implementing permanent institutions, but say the time has come to do more for the growing populations of residents.

"People have a right to be proud of where they are," said Sandi Hilal, the director of UNRWA's carefully named "camp improvement program" in the West Bank, adding that providing just basic needs "is not enough when we consider people have been living in a place for 60 years".

"Improving the daily life of refugees doesn't jeopardize their right to return back home. Living in dignity is the main goal of the improvement program," she said.

Some 700,000 people fled or were driven from their homes when Israel was created after the 1948 war, but now as many as five million refugees and their descendants live in Lebanon, Syria, Jordan, the Gaza Strip and the West Bank, many of them in squalid camps.

Founded in 1949, UNRWA is almost as old as the UN itself. Given that prospects for a resolution to Israel's disputes in the Middle East continue to be dismal, it appears to have a long future ahead.

With the help of German government funding, the agency is improving health clinics, sanitation and advanced education in coordination with local committees in five camps in the Israeli-occupied West Bank and two in Jordan.

Clinging to hope

The 13,000 residents of Bethlehem's Duheisha camp, a warren of cinder block hovels clogged with traffic and electrical wires, are a focus of UNRWA's efforts.

The agency leased the site months after some 2,000 original refugees left towns and villages around Jerusalem in 1949.

The fate of refugees clinging to the right of return has been one of the toughest issues facing negotiators in two decades of on-off talks aimed at creating an independent Palestinian state in Gaza and the West Bank.

Israel says the demand for a right to return is a deal breaker in any peace accord, arguing that allowing the refugees into Israel would increase the proportion of Palestinians living within its borders and thus undermine its nature as a Jewish state.

It also disputes the legal basis of the right of return set out in a UN resolution of December 1948 and says the world has not taken into account the plight of Jews forced from their homes across the Arab world in the last 65 years.

Peace talks have been frozen since 2010, with the Palestinians saying they will not re-engage until there is a halt to Jewish settlement building in the occupied territories.

The dejection found in Duheisha has not been reversed by the UNRWA plan to improve it or by the work of 20 non-governmental organizations in its one-km-square area.

As walls turned from felt to cinder block over decades, houses squashed together, pushing community life out into the surreally narrow streets. With no parks for children to play in and few jobs to keep youths busy, people of all ages mingle in its crowded alleyways.

"Standards of living here are plunging," lamented part-time laborer Othman Abu Omar, puffing idly on a cigarette.

"We hope one day to be done with dependence. Everybody should depend on himself," he said.

Hoping 'to disappear'

Some residents complain that the decades of UN sponsorship have amounted to nothing more than charity, without addressing the underlying political cause of their plight.

"We've gotten health and basic services, but there is no end to the crisis," said Habis al-Aisa, a camp dweller whose family hails from Zakariyya, a town in what is now central Israel.

"We're refugees, and the UN should be totally responsible for our needs and our situation, because our status is an international political issue."

The United Nations recognizes as refugees those who registered with UNRWA after fleeing their homes and their descendants. They are covered by the UN resolutions and eligible to receive the agency's services even if not resident in the camps, but not if they attain citizenship or asylum in another country.

Historically weak and cash-strapped governments in Palestinian-governed Gaza and the West Bank have provided little in the way of infrastructure or subsidies to the camps or their inhabitants. Many remain in the camps for lack of better options.

UNRWA is the only UN organization devoted to the refugee problem of a single people. Its spokesman, Chris Gunness, said it has no set policy on where the refugees are to go, or how the Middle East crisis might end.

"UNRWA would like nothing more than to disappear and not be needed anymore. It provides services pending a just and durable solution to the conflict," he said.

The agency's current improvement scheme, subsidized by 19.5 million euros from the German government, stresses close coordination with local parties.

A gleaming new clinic aims to provide services to sufferers of diabetes and hypertension, which afflicts around a sixth of refugees in the West Bank, who previously had few options for treatment.

Living conditions will be improved by shoring up collapsing houses, mending roofs and improving sewage and trash collection.

In a college-level education program, dubbed the "House of Wisdom" after a Baghdad library in the Islamic golden age, young camp dwellers choose their own curriculum and are visited by guest lecturers in small, Socratic learning circles.

"194, 242, 338," student Alaa al-Homuz rattles in staccato, naming UN Security Council resolutions dealing with Palestinian refugees which he is studying in a class on international law.

These students disagreed that improving the conditions in the camps would interfere with the concept of the right of return or dull their determination to return to their ancestral homes.

"When you live better and have your essential needs met, it leads to a better way of thinking and to finding better strategies to get our rights," al-Homuz said.