I don't know how the iPod firmware deals with disc errors, it may be that it automatically marks any bad blocks as unusable and reduces the reported capacity of the drive accordingly

Have you updated the iPod firmware to 1.1.2 lately? It takes up a lot of space.

I'm sure you mean 1.1.2 

My 160GB Classic reports 'capicity: 148.79GB'. You have to understand that the software that runs an iPod - menu systems, album artwork, photos and video (even though your 4th Gen doesn't have those features), games etc. - is substantial and large in size. Taking mine as an example, it's using 11GB just for the software that runs it and the add-ons. By comparison, my Windows directory on this computer is only 2.28GB in size.

As far as I know, the only way of defragging and sorting out potential iPod disc errors is to reset the iPod to 'original settings' but, of course, you'll lose everything you currently have on your iPod. Personally, I don't think there's anything wrong with your iPod - you've just been taken by surprise at how big the iPod's Operating System is. 

exactly the same here.  It hadn't occurred to me until your post just how big the firmware on these things is 



I don't think freestate realised that your's is a fourth generation ipod, 1.2.1 is the latest for that model - 1.1.2 is the latest for the sixth generation ones

My 20GB 4th Gen is running Software Version 3.1.1 - which is current. It reports 'Capacity: 18.58GB' so even on an itty-bitty old one the iPod's OS still takes up ~1.5GB