DAVOS, Switzerland - Foreign Minister Tzipi Livni warned Palestinian Authority Chairman Mahmoud Abbas Thursday that should he reach a compromise with Hamas, that would send the diplomatic process into a deep freeze.

"Compromising with extremists will not promote anything, but it can lead to further stagnation," Livni told Abbas during a session of the World Economic Forum in Davos, Switzerland.

Abbas, though not mentioning Hamas by name, responded by saying that should the Islamic organization refuse to honor agreements signed by the Palestine Liberation Organization or to accept proposals that have the support of the Arab world - an apparent reference to the Arab League's Beirut declaration of 2002 - he will call new elections.

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Any Palestinian government, he said, must accept previously signed agreements and ease the suffering of the Palestinian population. Thus if the various Palestinian factions cannot agree on such a platform, he will call new elections and let the Palestinian people choose their leadership and their platform.

Both Livni and Abbas stressed a desire for a two-state solution, but disagreements were evident on the subjects of borders and the Palestinian refugees.

Livni said that under any deal, the refugees should be resettled in the Palestinian state. This state, she explained, will be the national homeland of all Palestinians, including the refugees, and it is therefore the only appropriate solution for resettling them.

Regarding borders, Livni said this must be a subject for negotiations, and that while she did not want to outline her ideas now, she felt obligated to respond to Abbas' statement that a Palestinian state must be established "in the 1967 borders."

In 1967, she said, there was no Palestinian state, or any connection between Gaza and the West Bank; something new is being created. And while a Palestinian state is also an Israeli interest, she added, the borders must be the result of negotiations between Israel and the Palestinians.

Any Palestinian state must also recognize Israel's right to exist and renounce terror, Livni said.

Abbas, in contrast, insisted on the pre-1967 lines and a "just solution" to the refugee problem based on UN General Assembly Resolution 194. That resolution states that "refugees wishing to return to their homes ... should be permitted to do so at the earliest practicable date."

Abbas added that a comprehensive solution is needed, rather than another partial or interim solution, and he urged Israel to begin final-status talks now.

Vice Premier Shimon Peres, who also addressed the gathering, announced a trilateral Israeli-Jordanian-Palestinian agreement to develop a joint economic zone in a 500-square-kilometer region of their mutual border, and urged all those attending the WEF to invest there.

Deputy Defense Minister Ephraim Sneh told Haaretz that Israel and the Palestinians have also agreed to establish a joint, $25 million venture capital fund that will invest in technology projects in Israel and the PA.

In a brief reference to Israel's domestic woes, Livni also said in her speech she hopes Peres will be the country's next president - a remark that drew a lengthy round of applause