The Israelites could have been the world's perpetual premier nation if they had done as God asked. But they failed, proving that no nation, no people - even with the righteous examples of Abraham, Isaac, and Jacob and with the great laws of God - could solve humanity's problems and live peaceful, abundant lives without a special ingredient only God can supply.
Men say, "With enough time and enough knowledge, we can solve any and every evil." But the record of humanity, foremost in Israel, has proved that it cannot be done. Even with God as their King, Israel could not succeed in this. Something was missing.
What was missing? God's Holy Spirit! It was evident, even during the days of the prophets, that the Old Covenant was insufficient, that its terms could not redeem a person from his sins or deliver eternal life. A new and better covenant was needed. God will make a New Covenant with Israel, one that will include an element whereby He can write His law on people's minds and hearts. By this means, His way of living will be their way too, and they will be faithful to Him.
Paul comments on this in Hebrews 8:7-8, adding that the failure of the Old Covenant lay in the Israelites themselves. They had hearts of stone on which God could not write His way of life. While that covenant was in force, He purposely withheld the vital, heart-softening ingredient, His Spirit, from them as a whole to depict to mankind that peace, prosperity, and redemption are impossible without a spiritual relationship with Him. He must be personally and individually involved in their daily lives.
One day, in the Millennium, He will give Israel that ability - that right heart - and allow them to succeed in the areas in which they failed. This is prophesied in Ezekiel 37:21-23, 26-28:
Thus says the Lord GOD: "Surely I will take the children of Israel from among the nations, wherever they have gone, and will gather them from every side and bring them into their own land; and I will make them one nation in the land, on the mountains of Israel; and one king shall be king over them all; they shall no longer be two nations, nor shall they ever be divided into two kingdoms again. They shall not defile themselves anymore with their idols, nor with their detestable things, nor with any of their transgressions; but I will deliver them from all their dwelling places in which they have sinned, and will cleanse them. Then they shall be My people, and I will be their God. . . . Moreover I will make a covenant of peace with them, and it shall be an everlasting covenant with them; I will establish them and multiply them, and I will set My sanctuary in their midst forevermore. My tabernacle also shall be with them; indeed I will be their God, and they shall be My people. The nations also will know that I, the LORD, sanctify Israel, when My sanctuary is in their midst forevermore."
Israel will then be given the New Covenant. They will be allowed wholesale access to God through His Holy Spirit, and they will keep His laws along with the statutes and the judgments. They will not just pay them lip-service. This time they will keep their covenant with God.
Moreover, the nations will notice when Israel finally does what it was chosen to do. The Gentiles will begin making the right connections. They will see that God has sanctified the Israelites by setting them apart, giving them His Spirit and His law, and blessing them abundantly for their obedience. They will say, "Maybe we should be doing this too!" and begin to fulfill Isaiah 2:1-4. Thus, during the Millennium, Israel will perform its original purpose as a model and mediatory nation for the rest of the world.
It will take time, maybe generations, but slowly, surely, the whole world will see in Israel, then part of God's church (see Galatians 6:16), how it should live under God. There will be conversions by the thousands - perhaps even by nations, as they realize what wonderful peace and prosperity can ensue when a nation obeys God and lives the way that He teaches!