According to the H-O Theorem, the determinants of trade are explained in terms of factor endowments of countries and factor intensities of goods. A country specialises in and exports that good, which intensively uses its most abundant factor. For example, if a country like India is abundant in labour then India would mainly specialise in labour-intensive goods that would form a large share of its export basket. In the same vein, India would import capital- intensive goods from countries that are capital-abundant.
It is the ratio (or proportion) of one factor to another that gives the model its generic name: the factor-proportions model. In the H-0 model the ratio of the quantity of capital to the quantity of labour used in a production process is the capital-labour ratio. Therefore it is assumed that different industries producing different goods have different capital-labour ratios.
In a model in which each country produces two goods, an assumption must be made as to which industry has the larger capital-labour ratio. Thus, if the two goods that a country can produce are electronics and textiles, and if electronics production uses more capital per unit of labour than is used in textiles production, we can say that the electronics production is capital-intensive relative to textiles production. Also, if electronics production is capital- intensive, it implies that textiles production must be labour-intensive relative to electronics.
Countries have different quantities or endowments of factors capital and labour, available for use in the production process. Thus, some countries like theUS are well-endowed with physical capital relative to its labour force. In contrast, many less developed countries have very little physical capital but are well-endowed with large labour forces. The ratio ofthe aggregate endowment of capital to the aggregate endowment of labour is used to define relative factor abundance between countries.