Knights looking down from a castle provide a grand entrance to Malta's Playmobil theme park. Lifesize figures of a farmer and a pirate tower over children at the Playmobil farm where youngsters can ride pigs and a crocodile, "milk" a cow (it's only water) and ride narrow-waisted horses.

The original FunPark at the German toymaker's headquarters in Zirndorf in Bavaria is much bigger, but the Maltese version is popular. "There isn't much here [in Malta] for children," says Noel Zarb, a salesman at Playmobil Malta. He says local children come every day.

A 45-minute tour of the adjacent Playmobil factory (£7 including FunPark entry), the company's second-largest, is also a highlight. Children discover how the seven parts of a 7.5cm Playmobil figure, with its ever-smiling face, are made from tiny plastic granules and put together to form princesses, pirates, police officers and secret agents.

In Malta, Playmobil makes 2m of the tiny precision-moulded figures every week – five times the island state's total full-size population.

At a time when 80% of the world's toys are made in China, Playmobil has stubbornly resisted pressure to shift production to the far east. Helga Ellul, the head of Playmobil Malta, says the company looked at it eight years ago but found that the cost advantage was not that big, partly because its main export markets are in Europe. Since then, Chinese wages have risen.

Playmobil is also anxious to retain control over quality. The company's owner, Horst Brandstätter, once told his workers: "If we wanted to produce in China, I would have to clone you all."

The toymaker only produces a few electronic parts in China, for example for the new Top Agents series and the flashing light atop its police car. Its Danish arch-rival Lego – the top toy brand in Germany, which has relegated Playmobil to second place – is also largely manufactured in Europe, although it has moved more production to the far east than Playmobil.

The plastic figures owe their existence to the 1970s oil crisis. The family-owned parent company, which started out making toy telephones and brought the hula hoop to Europe, asked its head designer, (then called 'sample maker') Hans Beck, to come up with a smaller toy to save on plastic. He sketched out a short figure with a smiling face, but dropped the nose after children told him it looked like a clown. Initially the legs could be moved separately, but he found that made the figure unstable and opted for legs that only move in tandem.

"At the time we only had big dolls and tin soldiers," recalls Ellul. "Mr Beck's idea was to create a small world for children, a replica of what they live in. None of us, not even Mr Brandstätter, knew the power of this toy at that time."

The basic design has not changed since then and today's accessories are compatible with the original figures. Production started in Malta in 1974, where the unemployment rate was 20%, whereas Germany had close to full employment. Maltese wages were only a 10th of those in Germany (they have now risen to between a third and a half). The Maltese government lured foreign companies with tax breaks and paid for the building of the Playmobil factory. Today Playmobil employs 900 people in Malta – the second-largest employer after ST Microelectronics.

The ever-expanding Playmobil world scores highly on gender equality - there are female firefighters, police officers and vets – but does less well on multiculturalism – there aren't many non-white characters.

It regards itself as a predominantly European brand. "It is very much a toy that appeals to the European culture," says Ellul. "We are in the US and Canada but feel it is much more difficult to get our message across."

Britain also falls into this camp: its children are seen as less keen on role-playing than those on the continent and regarded as having a shorter attention span. "Too many video games, children being left alone at home in front of the telly, both parents working," says the UK commercial director, Graham Brennan.

"There is a huge difference between the social sectors in the UK. In Europe it's more evenly paced. And French children love collecting." France is Playmobil's biggest export market.

Even though the UK is a small part of Playmobil – it generated sales of just £20m last year out of a group total of €507m (£439m) – there are plans to open a theme park in the south-west within the next five years. "It's a question of when – not if," says Brennan. Sometimes Playmobil is a little too close to life. Brennan recalls a barrage of complaints when Playmobil produced a female figure bottle-feeding a baby in a hospital. "People complained saying you are telling young girls not to breast-feed," he says. "I pointed out to them that it is just a toy."

Some 24,000 tonnes of plastic go into making Playmobil toys every year. Pellets of clear plastic are mixed with coloured granules, heated up and injected into moulds. The machines spit out 32 heads every 20 seconds, still hot. The eyes and mouth are injected from inside the face rather than printed on so they don't rub off. Some 46 km of overhead pipes ferry the plastic around the Maltese factory.

The whole process is automated, except for the bagging and boxing at the end, and takes about five minutes. One giant machine assembles the figures part by part – a 'skeleton' holds everything together – and cameras monitor every move. If a figure is found to have a part missing, it is despatched into a bin. More complex characters such as Santa Claus are assembled by hand.

Unlike other toymakers, Brandstätter, 78, who wants to hand over the company to a foundation when he retires, has resisted TV or film tie-ins. Despite the success of Lego's Star Wars computer game, he is not interested in licensed toys, saying they get in the way of imaginative play. "Playmobil could easily do Harry Potter but licences are expensive," says Bernhard Hane, head of research and development.

But there are some signs that Playmobil, which has seen its target age group slipping from four to 10 to four to eight, is starting to move with the times. This year's Top Agents range, featuring a remote-controlled car with a video camera, is a nod to the popularity of hi-tech toys. But it's not all about gadgets. A Playmobil bestseller in the UK is the swimming pool with water slide. "The pool is selling exceptionally well. I think it's the guy with the Speedos!" says Brennan.