The transition had already effectively happened. Since the 77-year old Mahathir—a former physician—tearfully announced in June, 2002, that he wanted to quit, he has been slowly handing his duties to Badawi. Indeed, last spring Mahathir took a two-month vacation, leaving his deputy in charge as the SARS outbreak pummeled tourism and the war in Iraq brought angry Malays into the streets. Badawi’s diplomatically phrased formal objection to the Iraq war offended no one in the international community while appeasing protesters and showing that the heir apparent possessed a deft touch. "They are as much my people as they are Dr. Mahathir’s," Badawi told a U.S. official in late August.

In his long tenure, Mahathir clearly healed much of what ailed Malaysia. When he rose to power in 1981, the country still bore scars from violent race riots and a long fight against a stubborn communist insurgency. Since then, it has become a model of prosperity, civil order, and economic growth for Asia. Mahathir encouraged export-oriented manufacturing to wean Malaysia from its dependence on crude oil, rubber, and palm oil. His finance ministers and central bankers have kept the fiscal deficit reasonably low. He built high-quality roads, a world-class phone system, and the region’s best railroads. In 1980, Malaysia’s gross domestic product was $12 billion. Last year, it was $210 billion, and per capita income stood at $3,540, the third-highest in Southeast Asia after Brunei and Singapore. Many analysts believe that "Mahathir created a nation; there is real pride in the country."

Many analysts believe that "Mahathir created a nation; there is real pride in the country."

There’s little doubt that Badawi will present a far different public face to the world. Mahathir has earned a reputation both as a fierce defender of Asia against the West and as a tough political infighter at home. His successful prosecution of his deputy prime minister and rival, Anwar Ibrahim, on charges of sodomy and corruption—despite Anwar’s pleas of innocence—was the most glaring example. And he may be best remembered by many Westerners for his fierce anti-American outbursts and anti-Semitic statements. By contrast, the 63-year-old Badawi is known as a consensus-builder, a skill he learned in eight years as Foreign Minister. He is also the son and grandson of Islamic scholars and a student of Islam himself, earning him the respect of Malaysia’s new breed of fundamentalist Muslims, a growing political force. Badawi will have stronger Islamic credentials than Mahathir, so he’ll be able to tone down his rhetoric.

As Malaysia is being handed over to Badawi, on many levels the nation appears to be in good shape. The stock exchange is up nearly 20% since January, and the economy is expected to hit 4.5% growth this year. Foreign investors have long liked the political stability, good infrastructure, and relatively cheap skilled labor Malaysia offers. In exchange, foreigners have agreed to honor laws that require them to offer equity stakes in their enterprises to Bumiputras—a local term that generally means ethnic Malay Muslims—often members of Mahathir’s party, the United Malays National Organization (UMNO). While exceptions were made for exporters in some industries and the party’s involvement was rarely overt, the rules were understood and obeyed.

Badawi may have to be patient when it comes to pushing Malaysia up the ladder. During the boom years, Mahathir promoted a program called Vision 2020—a plan to transform Malaysia into a developed nation by 2020. It was based on the assumption that heavy spending on education, information technology, and other modern industries would do for Malaysia’s 24 million people what similar programs have done for Japan and Korea. Part of the business plan was the $4 billion "Multimedia Super Corridor," centered around Cyberjaya, an office park tailored to high-tech companies.

The $2.9 billion Petronas Twin Towers in Kuala Lumpur, which marry Islamic motifs with the soaring lines of New York’s Chrysler Building, are the world’s tallest skyscrapers.

That was before China became a competing industrial power. The government hails Cyberjaya as a success, but lately tech investors have stayed away, forcing it to market itself as affordable office space for low-tech call centers and back-office data processing. Malaysia’s investment in education, meanwhile, will take at least a generation to bear fruit. Badawi can get faster results by offering more incentives to foreign investors and opening the economy and financial system further. The world has changed, and Malaysia has been a bit complacent.

Nowhere are the problems more evident than in Penang. Once the pillar of Malaysia’s electronics industry, the steamy island in the Malacca Strait is hollowing out, with Seagate Technology, Motorola, Solectron Technology, and other multinationals shifting production elsewhere in Asia. Solectron, which makes equipment for Cisco Systems, Hewlett-Packard, and others, has already transferred assembly of PCs, cell phones, and routers for 10 of its clients to China. The company has kept some more sophisticated operations, such as design work, in Penang, but it expects to move that to China within two years. "All of us are quite concerned about the change in leadership in the country, whether it’s going to lead to positive or negative impact on this industry," says Joe Tang, a corporate vice-president at Solectron in Penang. Tang wants Malaysia to follow the lead of China, which has fostered the growth of local tech companies by wooing foreign investors while also building up the local supply base.

Business leaders with ties to UMNO may have even bigger worries if Badawi reins in outlays for the public-works programs that have been Mahathir’s signature. Since 1991, Malaysia has spent well over $15 billion on infrastructure projects such as the Kuala Lumpur International Airport. The $2.4 billion facility, which was built to resemble a cluster of Arabian tents, is designed to handle 25 million passengers a year but will see just 16 million this year. Although the city’s old airport at Subang was clearly overburdened, the new facility won’t likely reach full capacity until 2011, estimates brokerage ING Financial Markets. The $2.9 billion Petronas Twin Towers in Kuala Lumpur, which marry Islamic motifs with the soaring lines of New York’s Chrysler Building, are the world’s tallest skyscrapers. But one tower remains one-third empty, say real estate agents. And in the new capital, Putrajaya, built at a cost of $5.3 billion some 30 kilometers from central Kuala Lumpur, parking lots are landscaped like golf courses, and domed government office buildings are modeled after mosques. The city was built to relieve overcrowding in Kuala Lumpur, but foreign embassies have mostly stayed in the old capital, and the web of new highways around Putrajaya is empty much of the time.

Last year, the language of instruction in math and science courses at government schools was switched from Malay to English. Then a quota system in university entrance exams that gave Bumiputra students an advantage was adjusted to give academic merit more weight. Finally, on June 17, the law requiring foreign investors to have Bumiputra partners was repealed. Foreigners may now own 100% of a Malaysian company in most sectors.

The Bumiputra regulations aren’t the only restrictions Badawi wants to remove. In March he vowed to "rectify" the "excruciating" level of red tape at government agencies that regulate hotel management and land transactions. The government is also preparing to issue new licenses in the once closed-to-outsiders financial-services industry, says Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the central bank. "A lot of deregulation is taking place," says Mohamad Ariff, executive director of the independent Malaysian Institute of Economic Research.

Investors are delighted with the new rules. "As outsiders, we know it isn’t going to be in our favor if an industry is distorted through the industrial policy of a government," says Nicholas R.H. Bloy, director of private equity fund Navis Management. In 2001, Navis acquired a disposable-diaper factory in Malaysia from Houston-based Drypers Corp. after Drypers sought bankruptcy protection. Now, Bloy is negotiating to acquire two more Malaysian companies.

Badawi will take office at a time when Malaysia, like the rest of Asia, is benefiting from a global economic recovery. Gross domestic product grew at an annual rate of 4.5% in the first half, up from 2.6% during the same period last year. Manufacturing was the largest contributor, growing 6.2%, mainly from exports of semiconductors and household appliances. Some manufacturers have started exporting partially assembled products to China, where they are completed at less well equipped, more labor-intensive plants.

In the long run, that strategy may not hold as more companies shift production to China. But it’s working now: The inflow of foreign investment reached $1.46 billion from January to June, up from $928 million during the same period last year.

But Malaysia needs to do more to prepare for the challenge ahead. The economy has long been buoyed by oil-and-gas production, which contributes 7% of GDP. You want to be investing in R&D and education and skills for the time when oil exports run out.

Even the country’s troubled financial system is getting its health back. Loans at Malaysia’s 10 full-service banks—the product of a massive government-enforced consolidation of 54 financial institutions—grew 4% in the second quarter over the year-earlier period.

Foreign reserves have risen to $38.6 billion, enough to cover more than seven months of imports, up from five months in June, 2000.

With the stock market up sharply this year, fund managers from Asia, Europe, and the U.S. are waking up.

Part of the attraction may be that a new, more professional breed of manager is ready to take the helm at Malaysia Inc. The old generation of UMNO-linked CEOs often owned controlling stakes in their companies and gave short shrift to the needs of minority shareholders, say Malaysian economists and Western diplomats.

But new CEOs run many restructured UMNO-linked corporations. The companies compensate their managers with stock options, while before the crisis they received loans and substantial equity stakes. And they advertise themselves as managed by professionals without the interference of controlling shareholders. "These are quite early days, but I call it Malaysia Inc. II," says Nazir Razak, CEO of Commerce International Merchant Bankers, one of Malaysia’s biggest financial institutions.

Regardless of how well the economy does, Badawi will have to confront the rising tide of terrorism in Southeast Asia. And for that, he has already earned relatively high marks from Western diplomats, who praise Malaysia for providing a more secure environment for American and Australian interests than Thailand or Indonesia.

In his role as Home Minister, Badawi signed "detention orders" to hold people indefinitely—about 100 were under arrest at last count—without trial or formal charges under Malaysia’s Internal Security Act.

There’s little doubt that the handover of power will be smooth at first. But Badawi will come under enormous pressure to prove himself quickly in the political arena.