Malaysia has lost edge as low-cost producer.

Malaysia risks missing its goal of becoming a high-income nation as it has lost its edge as a low-cost producer and lacks the investment to compete in more advanced industries, the World Bank warned today.

In its first country report on Malaysia, the Washington-based body also said that as a trade-dependent country, Malaysia should not unwind its RM67 billion in economic stimulus as that could choke off a nascent recovery.

“The economy seems to be caught in a middle-income trap - unable to remain competitive as a high-volume, low-cost producer, yet unable to move up the value chain and achieve rapid growth by breaking into fast growing markets for knowledge and innovation-based products and services,” it said.

Private investment in Malaysia, which famously spurned advice and cash from the International Monetary Fund in 1998, is below that of virtually every other Asian country and has fallen dramatically since the Asian financial crisis.

According to World Bank data, private investment in Malaysia fell to 12 per cent of gross domestic product in 2008 compared with 30 per cent prior to the Asian crisis.

The government that has ruled this country for 52 years has announced a series of economic reforms aimed at winning back foreign investment that increasingly finds a home in neighbouring Thailand and Indonesia.

However, portfolio and direct investment flows have been negative since the second quarter of 2008 and there have been few signs that investment has picked up in response to the government measures.

The World Bank noted that while Malaysia has a high proportion of high tech exports it served as a low-skilled assembler of imported parts “rather than a creator of technological and product innovations”.

One major limitation on moving up the economic value chain is Malaysia’s education system, which churns out tens of thousands of graduates who are ill-equipped for the kind of high-value work such as biotechnology that the government has identified as growth areas.

Education in Malaysia has become mired in a deep political row as the government recently switched to Malay language instruction for math and science from English, a move critics said was designed to appease its ethnic Malay voter base.

While private investment has plummeted, the government’s spending has risen sharply. Malaysia expects to rack up its biggest budget deficit in 20 years at 7.4 per cent of gross domestic product this year.

The government expects the economy to shrink 3 per cent this year and to grow by 3 per cent next year, although the World Bank was more optimistic.

“With East Asia leading the recovery and advanced economies showing progressive improvement, the Malaysian economy is projected to grow at 4.1 per cent in 2010, following a contraction of 2.3 per cent in 2009,” it said.

The bank was, however, less optimistic on the government’s plans to slash the budget deficit in 2010 to 5.6 per cent of GDP, forecasting that it would be 6.4 per cent of GDP.