ARIEL, West Bank—When the Jewish settlers who founded this town scouted the land in 1978, they chose a rocky outcrop where Palestinian villagers warned nothing would grow. It was called the Mountain of Death.

“They thought we were crazy,” said Dorith Nachman, 70 years old, recalling the reaction when she, her husband and other Jewish Israelis erected tents on the hillside.

Ariel’s...