A decade of unrest later, Bethlehem has observed a rise in visits to the Christ's birthplace, causing an increased hope of tourism bonanza.
The Palestinian territories' top tourist destination is a victim of the barrier which cuts off the town from nearby Jerusalem, just 10 kilometres (six miles) away.
Israel began work on its sprawling barrier -- dubbed the "apartheid wall" by Palestinians -- in 2002 at the height of the second intifada, or uprising.
Palestinian tourism minister Rola Maayah sees the barrier as a key obstacle to encouraging visitors to the town.
"Bethlehem, one of our main tourist attractions is circled by 27 settlements. As a result, we are surrounded by high walls, fences and menacing checkpoints which put tourists off," Maayah said.
"We could develop tourism, attract people from all over the world, but it's not possible because of the Israeli occupation," she added.
The expansion of nearby Israeli settlements has deliberately helped to isolate the city, Palestinians say.
But since a UNESCO decision in June 2012 to grant world heritage status to Bethlehem's Church of the Nativity -- hailed as a "historic" diplomatic victory by the Palestinians -- the town has been eyeing a tourist bonanza that could boost the local economy.
In Bethlehem, where nearly one quarter of its 25,000 residents are unemployed, two out of three households rely on tourism for their income.
Between 2011 and 2012, more than two million people visited the town. The record crowds brought much-needed revenues after a tough decade for tourism during the second intifada.
"There was a significant jump in tourism in Palestine in 2012 with an 18 percent rise in the number of visitors," Maayah said. A little over half of these were foreigners.
With 3,800 rooms, Bethlehem accounts for nearly half of the West Bank's hotel capacity. But the occupancy rate (65 to 70 percent) is unevenly distributed throughout the year.
"We are booked up in advance for Christian holidays, but there are lots of empty rooms the rest of the year," said the deputy head of the Bethlehem board of commerce, Fairouz Khoury.
To redress this imbalance, Vera Baboun, a Palestinian Catholic and Bethlehem's first female mayor since 2012, aims to encourage visitors to stay longer.
"Our visitors should know that Bethlehem is not just about the nativity," said Baboun.
The pilgrims -- who mostly come from Russia, the United States and Poland -- descend on the town by the coachload, queueing to see the Church of the Nativity, one of Christianity's oldest and holiest, leaving immediately afterwards.
Those who linger for more than a few hours are rare.
"This year our motto is 'Come home for Christmas,' which means: take the time to wander around the alleys of the Old City, talk to the residents, help them to live here," Baboun explained.
"Bethlehem is not a museum," she said.
Palestinian tourist guides have also complained they suffer because of the favourable treatment granted to their Israeli competitors.
Some 150 Israelis are authorised to work as guides in Bethlehem, compared with 42 Palestinians permitted to work in Israel and east Jerusalem, the chamber of commerce said.
"They take more than 80 percent of the market," complained Mohammed Awadallah, a Palestinian guide.
But Israeli authorities, who have long courted the lucrative market in catering to Christian pilgrims in the Holy Land, deny the accusations.
"We do everything we can so that Christians can visit the holy sites," Israeli Tourism Minister Uzi Landau said.