The postgraduate system in the UK's universities is failing to produce the number of highly skilled staff needed by a modern economy, a report warns.
The Higher Education Commission says the system is geared towards attracting overseas students, rather than training more UK students.
The report warns that the UK is falling behind in investing in research.
A Department for Business, Innovation and Skills spokeswoman said: "We recognise there are some concerns."
The study from the Higher Education Commission calls for urgent reform of the postgraduate sector, saying that in its present state it will cause long-term problems for the UK's economy.
Postgraduate research has become increasingly important for innovative, hi-tech industries.
But the Higher Education Commission, an independent group of education and business leaders, warns that the UK's current system seems to neglect UK students and instead is driven by universities wanting to recruit overseas students who pay high levels of tuition fees.
It says this risks making the UK the "education outsourcing capital of the world" - training international students rather than providing home-grown talent for UK firms.
Without an expansion of UK postgraduate students, it will mean UK firms will have to recruit more staff from overseas - or even have to re-locate to countries with a higher skilled workforce, the report says.
"We can't compete with countries like China and India on numbers, but we can compete, and win, on ideas and innovation. The postgraduate sector needs to be brought in from the cold and hardwired into the UK's strategy for economic growth," said Graham Spittle, IBM's chief technology officer, who chaired the group preparing the report.
The report identifies the scale of the growth of overseas postgraduate students - up 200% since 1999 - compared with a rise of 18% for UK students.
Within the group of countries in the wider European education area, it says that apart from England and Wales, the only other countries to have so few home students staying on for postgraduate are Andorra and Kazakhstan.
It calls for a reform of the support available for postgraduate students - so that they will not be deterred by higher tuition fees or difficulties in getting loans.
Earlier this year a report from the 1994 Group of research intensive universities warned of a looming crisis in postgraduate education - with a warning that successive governments had failed to address the problems facing this sector.
The vice chancellor of Oxford University has also highlighted his concerns about the funding of postgraduate studies.
A Department for Business, Innovation and Skills spokeswoman said: "We have asked the Higher Education Funding Council for England to monitor and review participation in postgraduate study as part of a longer-term assessment of the impact of the funding changes."