Want a clear sign that the '80s are coming back? Even luxury cars may be getting downsized.

Take General Motors (GM). Right now, the company's designers and product planners are toying with a project called the micro-premium car. If GM builds such a pint-sized, top-shelf car, it would face off against the likes of the Mini Cooper, the BMW 1-series, and the Audi A3.

Throw in the fact that GM, Ford Motor (F), and others are using smaller engines in their luxury cars, and it's clear that the newly approved fuel economy rules and $100-a-barrel oil are making a deep impact on how Americans will drive, even rich Americans.

"They're doing the right thing," says John Wolkonowicz, analyst with Waltham (Mass.)-based Global Insight. "It's in keeping with the new reality."
How to Build It

The challenge for GM is finding the right hardware to build its upscale small car. The company has a Korean-engineered platform that it will use to build mini cars for Asia. Last April, GM showed three mini cars at the New York Auto Show that could be built using the same platform. One of those cars, a hatchback called the Beat, will go into production in a couple of years.

But insiders say the subcompact hardware may not offer well-heeled buyers the kind of ride and handling they want in a higher-priced model. So GM is looking at using the chassis from its German Opel unit or a small, rear-wheel-drive platform that is under development.

In any case, GM thinks that even some luxury buyers will start thinking smaller. But they will still want bold styling and creature comforts inside. Says one GM executive: "It's a given that everyone will have to de-couple luxury from size if we are to make that 35 mpg."
How to Brand It

GM has another quandary if they decide to make the expensive mini car. Which brand will sell it? They could sell it as a Cadillac, but inside sources have told BusinessWeek that GM wants to preserve the brand's image for big, high-powered cars. Chevrolet is fast becoming GM's green technology division, but it won't command the price needed for a more expensive model.

GM is considering Buick, Saab, and Saturn but is nowhere near a decision. In fact, the company doesn't yet have clay models for the car.

That said, the automaker is motivated to find a way to build and market a luxurious small car—and not just by fuel economy. GM has discovered that Gen Y's twentysomething buyers don't hold a grudge against domestic brands the way Generation X and some baby boomers do.

The company figures if it can make a small car that is both fuel-efficient (Gen Y is more environmentally conscious than other cohorts) and has real cachet, they could make inroads with a generation that is fast growing into its car-buying years. "Domestic brands aren't necessarily on their shopping list," Wolkonowicz says. "But they're more open to looking at them."
Trading In the V8

Domestic automakers are also striving for fuel efficiency by downsizing engines. GM said this month it has canceled plans for a new V8 engine for luxury cars. Cadillac will still offer one, but it's putting more of its capital toward efficiency.

Both the Cadillac STS sedan and the SRX crossover SUV offer V8 engines, but buyers have largely opted for the V6, says company spokesman Thomas Read. About 85% of buyers of those two models take the V6.

And why not? The V6 kicks out 302 hp while getting about 21 miles per gallon. The more expensive V8 engine gets 320 hp but only 18 mpg.

Ford is following suit. Its forthcoming flagship Lincoln MKS sedan, which hits the market this fall, won't even offer a V8. It will run on a 3.7-liter V6 to start. In 2009, Lincoln will follow up with a 3.5-liter twin-turbo engine designed to get V8 power, but with highway fuel economy that exceeds 25 mpg, Wolkonowicz says.

Even if GM doesn't make the micro-premium car, expect engines to shrink and fuel economy to rise.