The former president of the World Bank had been serving as an envoy to the Quartet group of international mediators to the region - the UN, US, EU and Russia.
At a press conference on Monday in Washington alongside Condoleezza Rice, the US secretary of state, Wolfensohn announced his resignation after just one year on the job.
"With the government of Hamas having taken over with the Palestinians, it's a very difficult movement to be able to try and negotiate any independent type of arrangements," he said.
Wolfensohn said he believed he had made progress in promoting economic development in Gaza since the Israeli withdrawal last year.
But he said the situation had changed following the Hamas victory in January's Palestinian elections.
"The political events are such that I think the issues are above my pay grade," he said.
Warning to West
However, his final report questioned the decision of Western governments to cut aid to the Palestinian Authority.
The US and EU have cut financial aid to the Hamas-led government until it renounces violence, recognises Israel and agrees to honour previous agreements made by the Palestinians.
He said recent pledges of aid from Arab governments would provide only temporary relief to the funding crisis that faces the Hamas government.
The report also stated that the UN and NGO's did not have the capacity to provide aid direct to the Palestinian people - a solution suggested by some EU government leaders.
Wolfensohn, who had frequently complained of being "disenfranchised" in his Gaza role and threatened to quit, left with a warning that the West should not consider trying to starve the Hamas-led Palestinians into submission.
"I don't think anyone in the Quartet believes that to be the policy - although, sometimes, it is made to appear that that is what it is," he said.
"I think that's a losing gambit."