H-O Theorem:

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.