From 1949 on, sentiment for nationalization of Iran's oil industry grew. In 1949 the Majlis approved the First Development Plan (1948-55), which called for comprehensive agricultural and industrial development of the country. The Plan Organization was established to administer the program, which was to be financed in large part from oil revenues. Politically conscious Iranians were aware, however, that the British government derived more revenue from taxing the concessionaire, the Anglo-Iranian Oil Company (AIOC--formerly the Anglo-Persian Oil Company), than the Iranian government derived from royalties. The oil issue figured prominently in elections for the Majlis in 1949, and nationalists in the new Majlis were determined to renegotiate the AIOC agreement. In November 1950, the Majlis committee concerned with oil matters, headed by Mosaddeq, rejected a draft agreement in which the AIOC had offered the government slightly improved terms. These terms did not include the fifty-fifty profit-sharing provision that was part of other new Persian Gulf oil concessions.
Subsequent negotiations with the AIOC were unsuccessful, partly because General Ali Razmara, who became prime minister in June 1950, failed to persuade the oil company of the strength of nationalist feeling in the country and in the Majlis. When the AIOC finally offered fifty-fifty profit-sharing in February 1951, sentiment for nationalization of the oil industry had become widespread. Razmara advised against nationalization on technical grounds and was assassinated in March 1951 by Khalil Tahmasebi, a member of the militant Fadayan-e Islam. On March 15, the Majlis voted to nationalize the oil industry. In April the shah yielded to Majlis pressure and demonstrations in the streets by naming Mosaddeq prime minister.
Oil production came to a virtual standstill as British technicians left the country, and Britain imposed a worldwide embargo on the purchase of Iranian oil. In September 1951, Britain froze Iran's sterling assets and banned export of goods to Iran. It challenged the legality of the oil nationalization and took its case against Iran to the International Court of Justice at The Hague. The court found in Iran's favour, but the dispute between Iran and the AIOC remained unsettled. Under United States pressure, the AIOC improved its offer to Iran. The excitement generated by the nationalization issue, anti-British feeling, agitation by radical elements, and the conviction among Mosaddeq's advisers that Iran's maximum demands would, in the end, be met, however, led the government to reject all offers. The economy began to suffer from the loss of foreign exchange and oil revenues.
Meanwhile, Mosaddeq's growing popularity and power led to political chaos and eventual United States intervention. Mosaddeq had come to office on the strength of support from the National Front and other parties in the Majlis and as a result of his great popularity. His popularity, growing power, and intransigence on the oil issue were creating friction between the prime minister and the shah. In the summer of 1952, the shah refused the prime minister's demand for the power to appoint the minister of war (and, by implication, to control the armed forces). Mosaddeq resigned, three days of pro-Mosaddeq rioting followed, and the shah was forced to reappoint Mosaddeq to head the government.
As domestic conditions deteriorated, however, Mosaddeq's populist style grew more autocratic. In August 1952, the Majlis acceded to his demand for full powers in all affairs of government for a six-month period. These special powers were subsequently extended for a further six-month term. He also obtained approval for a law to reduce, from six years to two years, the term of the Senate (established in 1950 as the upper house of the Majlis), and thus brought about the dissolution of that body. Mosaddeq's support in the lower house of the Majlis (also called the Majlis) was dwindling, however, so on August 3, 1953, the prime minister organized a plebiscite for the dissolution of the Majlis, claimed a massive vote in favour of the proposal, and dissolved the legislative body.
The administration of President Harry Truman initially had been sympathetic to Iran's nationalist aspirations. Under the administration of President Dwight D. Eisenhower, however, the United States came to accept the view of the British government that no reasonable compromise with Mosaddeq was possible and that, by working with the Toudeh, Mosaddeq was making probable a communist-inspired takeover. Mosaddeq's intransigence and inclination to accept Toudeh support, the Cold War atmosphere, and the fear of Soviet influence in Iran also shaped United States thinking. In June 1953, the Eisenhower administration approved a British proposal for a joint Anglo-American operation, code-named Operation Ajax, to overthrow Mosaddeq. Kermit Roosevelt of the United States Central Intelligence Agency (CIA) traveled secretly to Iran to coordinate plans with the shah and the Iranian military, which was led by General Fazlollah Zahedi.
In accord with the plan, on August 13 the shah appointed Zahedi prime minister to replace Mosaddeq. Mosaddeq refused to step down and arrested the shah's emissary. This triggered the second stage of Operation Ajax, which called for a military coup. The plan initially seemed to have failed, the shah fled the country, and Zahedi went into hiding. After four days of rioting, however, the tide turned. On August 19, pro-shah army units and street crowds defeated Mosaddeq's forces. The shah returned to the country. Mosaddeq was sentenced to three years' imprisonment for trying to overthrow the monarchy, but he was subsequently allowed to remain under house arrest in his village (Ahmad Abad) outside Tehran until his death in 1967. His minister of foreign affairs, Hosein Fatemi, was sentenced to death and executed. Hundreds of National Front leaders, Toudeh Party officers, and political activists were arrested; several Toudeh army officers were also sentenced to death.