Europe's largest economy has been fertile ground for the iShares MSCI Germany Index Fund (AMEX:EWG), which enjoyed a 35% return in 2006. The fund uses a representative sampling strategy to track its benchmark, which consists of stocks traded primarily on the Frankfurt Stock Exchange. Insurance stocks make up roughly 12% of the fund, while chemicals, autos, and industrials each comprise about 10%, and electric utilities roughly another 9%. The fund has an expense ratio of 0.54%.

Export machine
The German economy is export-oriented, with industrial goods from multinationals such as the auto makers, machine-tool makers, and chemical manufacturers playing a major role in the economy. A number of these firms are well-known, world-class companies. This just goes to demonstrate how competitive German companies can be, especially considering the difficulties they face in their home market.

Heavily anchored
Germany exports not only industrial goods, but also jobs. A rigid labor market is a primary cause of persistently high unemployment and high wage costs. The high cost of doing business in Germany pushes domestic firms to outsource labor to less expensive locations whenever possible, further exacerbating the job situation.

Another drag on the economy is German reunification and the extent to which it is financed by social insurance contributions. There seems to be no immediate end in sight to these types of payments, and the government has plans to promote eastern economic development through 2019.

Although a mild winter has boosted the construction industry, Germany's slow-growing economy does not seem likely to change dramatically unless market reforms loosen up the current system. Structural unemployment, due to the difficulties of laying off redundant workers, means German domestic operational costs will continue to be high. In addition, the German consumer is conservative, and citizens save roughly 10% of their income. If Germans adopted the reckless American model of negative savings, just think of the consumer spending frenzy that would generate!

A long-term prospect
The top holdings in EWG are world-class multinationals, including Siemens AG (NYSE:SI), Allianz SE (NYSE:AZ), E.ON AG (NYSE:EON), Deutsche Bank AG (NYSE:DB), and DaimlerChrysler (NYSE:DCX). These companies have been extremely successful, even with the challenges they face domestically. One can only imagine how they would do if they were unfettered. Alas, that seems to be a long time in the future, if ever, given the current state of economic reform in Germany.

EWG had an outstanding year in 2006, but to expect that to occur again in 2007 seems overly optimistic. The long-term fundamentals seem to be positive for this fund and for Germany's role as a leading economy in Europe, and the competitiveness of its multinationals should be positive influences. With the German market up so high, patience may be required for a payoff with EWG.

Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She does not own any of the funds or stocks mentioned in this article. The Motley Fool has a strict disclosure policy, and any noncompliance is strictly verboten.