JERUSALEM, NOV. 26 -- Labor inspectors have been raiding businesses throughout Israel this month, detaining thousands of illegal Palestinian workers and fining their employers $250 for each of them. Officials say the raids are meant to send a message: the employment in Israel of an estimated 70,000 unlicensed Palestinians from the occupied territories, tolerated and even encouraged by the government for many years, must end.

In Jerusalem, an unofficial but more brutal kind of enforcement is being practiced. Today, police arrested at least three Jews who were supporters of anti-Arab Rabbi Meir Kahane, who was assassinated in New York last month, on suspicion of involvement in a campaign by self-appointed vigilantes who have been demanding that employers fire all their non-Jewish workers.

The official raids and the freelance attacks mark the parallel tracks of a movement that is rapidly gaining momentum here. Propelled by the right-wing government as well as a wave of intercommunal antagonism in the last month, Israel is plunging toward a policy that is being called "separation" -- the forced severing of the last, mainly economic, bonds between Arabs and Jews in the country.

So far, in the city's gritty, low-income Jewish neighborhoods where many Arabs work legally in shops, the stores of two merchants who refused the vigilantes' demands have been fire-bombed, and another shopkeeper and his Arab worker were attacked and stabbed. For their own protection, shops have begun posting signs: "No Arabs employed here."

Justice Minister Dan Meridor alluded to historical antisemitism today as he condemned the anti-Arab vigilantism. "All of us who have learned something of the history of the Jewish people are reminded of very harsh pictures from our past," he said on Israeli radio. "We should not tolerate expressions of racism."

The drive to separate Arabs and Jews is an initiative born of the upheaval in Israeli-Palestinian relations during the Persian Gulf crisis, and both communities are anxiously debating its meaning and possible consequences. Apart from the physical separation of the two peoples and their workers, the concept has a psychological aspect. For moderates on both sides, it means the abandonment of the notion that Israeli Jews and Palestinians can learn to accept each other, in favor of a theory that they can survive only by minimizing their contact.

The discussion has confused and divided the country's normally polarized camps: among Israeli Jews, there are leftists for and against separation, right-wing nationalists who welcome it and others who denounce it. Palestinian leader Faisal Husseini and the extreme rightist Tsomet Party both favor closing off the West Bank and Gaza from Israel, but Israeli military leaders, Palestinian economists and some peace activists oppose this.

Even as the debate continues, the separation process is surging forward, driven by the fear and anger many Israelis and Palestinians feel after a month of ugly violence. According to government figures, at least 3,000 of the estimated 108,000 Palestinians from the West Bank and Gaza Strip legally employed in Israel have lost their jobs in the last month, dismissed by employers frightened by the attacks on Jews launched by several Palestinian workers as well as the threats of Jewish extremists. So far, the campaign has not directly affected Arab citizens of Israel, who make up about 15 percent of the country's population.

Many of those Palestinians who can still find day work have been making the trip to the roadside "slave markets" less frequently, fearful that they will be a victim of one of the Jewish revenge attacks that have killed five Arabs in four weeks.

Earlier this month, a government committee proposed reducing Palestinian employment to 50,000 carefully screened workers within a short period of time. The Defense Ministry has more than doubled -- to nearly 20,000 -- the number of Arabs banned by name from entering Israel. It has increased checkpoints along the roads crossing the old Green Line, the boundary between Israel proper and the territories it seized in the 1967 Arab-Israeli war.

More extreme proposals have come from all sides. Leftist and rightist members of parliament separately have introduced legislation that would ban all Palestinian employment in Israel. Other leftists, including influential members of the Labor Party, advocate some form of unilateral Israeli withdrawal from parts or all of the territories, combined with an employment ban.

"Why think that unilateral withdrawal from the territories would be a bigger tragedy than our continued rule over a Palestinian population that daily expresses its total contempt for Israel," argued journalist Albert Schweitzer in the leftist Haaretz daily. "Israel's real task is to reach internal agreement on a map that we can live with as we must find a way to separate ourselves from the Palestinians."

In large part, the separation debate is the consequence of the upheaval brought by Iraq's invasion of Kuwait. Mass support for Iraqi President Saddam Hussein by Arabs in the territories rocked the Israeli peace camp, undermining its premise that the Palestinians and their leaders were ready for peaceful coexistence with Israel. Several leftist leaders decided Israeli-Palestinian dialogue was doomed, but continued to believe Israel should withdraw from the occupied territories. For these leaders, forced separation now offers the only viable answer.

"The reality is what counts," wrote Yossi Sarid, a member of parliament and one of the most outspoken members of the peace camp. "The Jews don't want and can't agree to the presence of the Palestinians because of knives in the back, and the Palestinians don't want to and can't come because of the punishments and torments that we inflict on them."

Sarid and several other leftist deputies support proposals that would eliminate Palestinian labor in Israel in a matter of months. In its place, they say, Israel can use immigrating Soviet Jews or other foreigners.

A leading Labor Party legislator, Gad Yacobi, has gone further, suggesting that the curtailment of employment be combined with a unilateral imposition by Israel of Palestinian self-rule in the territories, and withdrawal by the army from populated areas.

These ideas have been broadly supported by Palestinian political leaders, who share the view of the Israeli left that the physical separation of Israel from the Palestinian-populated territories would effectively recreate the Green Line and set the stage for creation of a separate Palestinian state. At the same time, economic separation is also backed by Israel's extreme right, which resents the dependence of Israeli firms on Arab labor and sees its elimination as the only way to ensure the security of Israelis from terrorist attacks.

The chief opposition to the proposals has come from military commanders charged with maintaining order in the territories. Shmuel Goren, coordinator of Israel's administration of the West Bank and Gaza, recently declared that banning Palestinian workers from Israel would merely turn the territories "into one big concentration camp" -- a view shared by some Palestinian economists.

According to Goren, Palestinians now earn $600 million annually working in Israel, and one-third of all Palestinians with jobs work in this country. If that income were lost, on top of the economic disruption already caused in the territories by the gulf crisis, there would likely be a new explosion of violence, Goren said.

The military's unease is quietly shared by the leaders of Israel's mainstream right-wing leadership, including Prime Minister Yitzhak Shamir and Defense Minister Moshe Arens. Shamir and his Likud Party colleagues, who have worked for years to persuade Israelis they should keep the occupied territories, had become as dependent as the left on the notion that Israelis and Palestinians can live together peacefully, albeit under Israeli sovereignty. To accept a necessity of separation would mean the abandonment of a key aspect of the Likud's ideology.

At the same time, the Likud leaders are beholden to their grass-roots constituency, which is demanding security from Arab attacks, so Shamir and his allies are trying to steer a middle course, reducing Arab labor in Israel while not eliminating it, and stepping up road checks while trying to avoid the appearance of recreating the Green Line.