Yes, you could convert them to a smaller size, but the quality will suffer considerably in any lossy de- and re-compression because it will make the combined artefacts much more audible.
For MP3s and other unprotected formats it would suffice to set the ripping format in the preferences to whatever you want, then select the titles in iTunes and then click Convert to [selected format] in the Advanced menu.
Protected files from the iTunes Store must first be burned to audio CDs and then re-ripped to the desired format.
For such a conversion I would recommend the AAC format since it provides better quality at much smaller file sizes than MP3. But as said above, you will always lose some quality in the process nevertheless.
I would generally not recommend this kind of conversion, however; I only have a 4GB nano and I use relatively high data rates including lossless compression for optimal quality. I simply swap files I had listened to for fresh ones when I have to charge it anyway (sort the iPod's library by Last played, delete the most recently played ones and drag fresh files from the iTunes library to the iPod).