According to Yaalon, in order to make diplomatic progress, the Palestinians must carry out a reform.
Speaking at the Herzliya Conference, the former chief of staff criticized the "failed" prevalent political perception in Israel and the West since the Oslo Accords.
He added that one of the important basic assumptions of this perception was being locked by the need to find a solution as soon as possible. "This perception must be replaced immediately," he said.
Yaalon slammed the approach expressed at November's US-sponsored Middle East peace conference, according to which a diplomatic and economic solution will bring about peace, and peace will bring abou security.
According to the former IDF chief, the reform in the Palestinian Authority should include five interwoven aspects which depend on each other.
At the first stage, Yaalon said, an education reform must be carried out.
"As long as the Palestinian education system preaches jihad, a holy war against Israel and a refusal to recognize Israel's right to exist, there is no chance for peace. A change is needed in the study program and the incitement in the public dialogue, the media and the mosques must stop."
The second stage, according to Yaalon, is a reform in law and order.
"There is need for police forces and a strong law enforcement system, which will not enable the existence of any gangs and armed organizations."
'Change regime to a democracy'The next stage is a security reform. "The Palestinian security organizations, which will work in full force to thwart terror, must be united. A security system is needed to deal with terrorism from the intelligence stage to the prosecution and punishment stage".
The fourth stage is an economic reform. "The Palestinian economy must be motivated and strengthened by strengthening the Palestinian middle class. This reform is aimed at rooting out corruption and encouraging businesspeople's economic initiative.
"Outside assistance, which will also be invested in developing the economic infrastructure is needed, and the process must be supervised by external bodies. In addition, we must bestow an economic culture of fairness and competition."
The last stage is a political reform. "We must lay the values of democracy and strengthen and bolster Palestinians willing to promote ideas of sanctifying the value of human life, rather than sanctifying death, and human rights rather than oppression.
"We must establish associations and institutions to strengthen a democratic regime, which will encourage, among other things, the freedom of expression and journalism. And the bottom line is changing the regime from a dictatorship to a democracy."
According to Yaalon, Israel's role in implementing the reforms is indirect, by providing the freedom of movement for people and goods from the outside.
The former IDF chief stressed that the reform could only be carried out in the West Bank, and not in Gaza.