The "literary urge" to turn the encounters between the Zionists Ze'ev Jabotinsky and David Ben Gurion into a play called Can Two Walk Together?, which opens at Tel Aviv's Cameri Theatre on Thursday, was planted in A B Yehoshua, one of Israel's most celebrated writers, by an odd discovery; during the meetings, Ben Gurion cooked an omelette for Jabotinsky, a man so impractical that he regarded opening a can of sardines as a triumph.

The detail cannot detract from the momentousness of the debates, the ideological division which still reverberates in today's failure to achieve consensus within Israel on how to end its conflict with the Palestinians

"Ben Gurion is in my blood," says Mr Yehoshua, 75, who as a student met the then Prime Minister in a "peculiar episode" in 1959. Ben Gurion was outraged by a commentator's claim that a Talmudic rabbi's pronouncements were no less authoritative than those of the biblical prophets of Israel. The 22-year-old Mr Yehoshua was engaged to scour the rabbi's works to help Ben Gurion disprove this fanciful proposition. Out of his payment – made from Ben Gurion's personal account – Mr Yehoshua bought himself a Vespa scooter, which he cheerfully named after the rabbi.

"The more time passes I see how he was right about many things," Mr Yehoshua says, including Ben Gurion's unequivocal – and ignored – advice to Israel immediately after the 1967 Six Day War to withdraw from the freshly occupied territories as soon as possible.

Jabotinsky, by contrast, was the father of the right-wing nationalist "greater Israel" camp (Prime Minister Benjamin Netanyahu's father Benzion, who died last month, worked as his private secretary).

But studying the encounters, Mr Yehoshua found the two men also had much in common. Both were not just secular, as Mr Yehoshua himself is, but "deeply secular". By contrast, these days, he says, "we in the peace camp" find the main opponents are religious, both the ultra-orthodox, and the religious Zionist settlers, who believe they are in the West Bank by divine right.

As he wrote the play, Mr Yehoshua began to wonder whether a Jewish state could have been created during the thirties, which might have saved perhaps a million from the Holocaust. Jabotinsky had believed it was possible, if the Zionists had been prepared to do more to force it on the British and Palestinian Arabs after the 1917 Balfour declaration backing a Jewish homeland in Palestine.

Whether "we could establish a state before the Holocaust is a very serious question... if we had the power to do it. I don't blame the British and I don't blame the Arabs. I blame the Jews who did not take seriously the opportunity," he says.

The two Zionist leaders split irrevocably after the meetings. At one point, Mr Yehoshua points out, Ben Gurion would even refer to his adversary as "Vladimir Hitler", and as Prime Minister he avoided bringing his body back to Israel for burial.

In June 1948, Ben Gurion was finally obliged to enforce the authority of the infant state by shelling the Irgun (Zionist paramilitary group) ship Altalena, when Menachem Begin – Irgun's leader and Jabotinsky's disciple – refused to unload its cargo of weapons. It was a clash between left and right, and arguably between the rule of law and anarchy that Mr Yehoshua says still "haunts" the search for a two-state solution.

It's a sign of Mr Yehoshua's outlook that the world premiere of the play (a rehearsed reading) was in London last week – the author's fund-raising gift to the UK New Israel Fund, which promotes democracy, equality, co-existence and human rights. He believes passionately in a two-state solution – but also that it is now too late to evacuate the West Bank settlements by force without a "civil war". "The only solution is to give them [the settlers] the possibility to stay as a Jewish minority in a Palestinian state," he says.

Under the Yehoshua plan – a version of which was also floated in the past by Palestinian Prime Minister Salam Fayyad – those settlers refusing to leave for compensation would have to become Palestinian citizens wholly subject to the new state's laws. If Palestinians "are serious about peace" then their own security forces, augmented by a European-led international contingent in the Jordan Valley, would preserve it. And for the Palestinians it would mean "getting the maximum territory they want" without "cutting it into pieces".

Despairing of the US's capacity to be a fair peace broker, Mr Yehoshua argues that this is now the European Union's job. "Europe would say, 'Ok... we are also guilty that we did not prevent the settlements before. But we know this is a trauma for you, if you will start to destroy them.'" Instead, it would cement the deal Mr Yehoshua envisages with an offer to each state to join the EU, saying: "This will be a gift we give to you if you make peace. This will tempt both sides to do it." And Mr Yehoshua, who objects to Mr Netanyahu's continued use of holocaust imagery to depict the Iranian threat, is convinced the best way to deflect that threat is to make peace with the Palestinians.

Intriguingly, one Israeli politician who is interested in his proposal on the settlers is Shaul Mofaz, who became Israel's Deputy Prime Minister in a coalition formed last week.

Mr Yehoshua also discussed his ideas with Defence Minister Ehud Barak, who raised the question of what would happen if a Jew was slaughtered in Hebron? Mr Yehoshua pointed out that Israelis have been attacked in Egypt without the peace treaty unraveling. "I said: 'If there are three Jews murdered in Toulouse, do you take your army to Toulouse?'"

On whether he is an optimist about a lasting peace agreement, he is equivocal: "With my wife I can permit myself to be pessimistic. But when I'm around more pessimistic people than me, I have to encourage them."