Small. It’s The New Big.

Europeans are following suit. Coming soon is Volkswagen's Up!, a funky four-seater that's about three and a half meters long. Last year, Fiat launched a remake of the classic Cinquecento (a.k.a. the Fiat 500). Peugeot already offers its tiny 107 city car, developed with Toyota, which sells a similar model called the Aygo (as in "I go"). On the high end, BMW is launching its diminutive 1 Series sedan in the United States starting at $29,375, making it the smallest Beemer on U.S. highways. "We are at a crossroads," says consultant Peter Schmidt of Automotive Industry Data in Britain. "An increasing proportion of the car-buying public has discovered a conscience."

One key country hasn't bought into small-is-cool: China. SUV sales rose 51 percent in China last year, big Buicks and VWs are all the rage and small cars go begging. Ratan Tata predicted that an automaker in China would be the first to match the Nano's $2,500 price, but analysts doubt that. "In China, image is more important than function," says China auto analyst Michael Dunne of J.D. Power and Associates. "Nobody wants to be seen on the bottom of the totem pole."

The biggest roadblock facing small cars is fear about safety. Chery's QQ suffered a PR setback when a video circulated on YouTube of a horrific crash in which the tiny car was crushed between two buses and the driver burned to death. A NEWSWEEK REPORTER TEST-drove a Chevy Aveo subcompact in Detroit last week and felt dwarfed by the SUVs. U.S. statistics on highway fatalities show the smallest cars have death rates 2.5 times higher than the biggest cars. In Europe, small cars, which are driven mostly at slower speeds in cities, have lower death rates, but are in more crashes than big cars. "It comes down to physics," says Adrian Lund, president of the Insurance Institute for Highway Safety. "If you're in a smaller vehicle out there, you're at greater risk."

To overcome small-car phobia, automakers are working to burnish their safety bona fides. In every Smart car showroom in the United States, for example, you'll find the car's reinforced steel skeleton on display. Called its "tridion cell," the steel cage protects occupants in a crash. The sales staff also shows prospective buyers violent crash-test videos and talks up the car's four airbags and electronic stability control. "In America," says Smart USA president Schembri, "you have to address this issue."

The more features automakers can stuff into small cars—be they safety, style or stereos—the better for the bottom line. This is the formula Japan and Europe have used to develop a lucrative small-car market. Typically, an automaker earns about a 5 percent profit on a car. That comes to about $125 on a Nano, $1,250 on a Mini Cooper or, better yet, $2,000 or more on a BMW 1 Series convertible. Putting premium-priced mileage misers on the road could help save the planet without bankrupting the world's automakers. The problem comes in convincing drivers in America and China—the world's two largest auto markets—that they should pay more for less. "Space and weight equal value for most buyers" in America and China, says analyst McAlinden. "It's a dollar-per-pound concept."

We may like to think that the recent spike in small-car sales is driven by altruism. But auto execs says it's a pocketbook issue: U.S. gas prices doubled this decade, and Western Europe is now paying about $2 per liter, up nearly 25 cents from just two years ago. "The worst thing that could happen to us now is if gas prices fell back, because that would take the pressure off," says Ford executive chairman Bill Ford Jr. "We've all started down this path now." And there's no turning back. Forecasters predict oil prices, global warming and emerging-market desire for cars will continue to rise. As long as those factors drive demand, small cars will rule the road.

With Jason Overdorf, Patrick Crowley, William Underhill, Mary Hennock, Stefan Theil and Akiko Kashiwagi

© 2008