I went back to Japan in June for a couple of weeks and was surprised to see how passenger vehicles keep becoming smaller and lighter. (I have been here in US for 4 years now, so the change was pretty striking) A lot of cars are not even under "compact" category....much smaller. They are also square to maximize their interior capacity. Now it sounds totally reasonable that Wagon R by Suzuki (not Prius!) is the top selling car in Japan for so many years.
There is a category called "light vehicle" in Japanese vehicle regulations; it enjoys less taxation and cheaper insurance. Also, the parkings are required to have lots dedicated to light vehicles (I guess much smaller than the lot for "compact" here in US). Wagon R is a light vehicle.
When Japan was a flourishing economy, driving light vehicle wasn't cool at all (besides being small, light vehicle has to carry different license plate to normal vehicles) ; people wanted more expensive, normal sized cars. But now, people are less interested in buying gorgeous cars. Or in buying cars at all. Cars are losing its value as status symbol as people's values and economic situation changes (downturn, obviously) and high gas prices (it's much higher than here in US). It's rather just a tool for transportation where efficiency gets priority.
Gas prices are getting high in US as well. There is surging interest in compact/small/energy efficient cars. If it comes with some tax/insurance relaxation, it will further stimulate the interest.
Definition of light-vehicle
Max length 3.4m (11")
Max width 1.48m (4.8")
Max height 2m (6.6")
Max displacement 660 cc
Max power 47kW