I was thinking of using an armor/shield system for a space ship shooter

I think it depends what kind of space shooter it is. This would work nicely for a slower paced, more sim-like space shooter like the old X-Wing vs Tie Fighter.. but probably couldn't work in a fast paced space shooter like Ikaruga.

I recommend looking at Tyrian (or Tyrian 2000, the name of the last DOS release of the game): It was a fast-paced shooter that used a shield and armor system, and while it's not QUITE like what you mentioned (for example: In Tyrian, you aren't allowed to adjust the shield's position, you died immediately when armor ran out, etc.), it's probably best that you have a look so you can get a feel for how such a system might work.

Oh, and Raptor: Call of the Shadows had a form weapon system damage: Every time you took damage below a certain amount of health, you lost one weapon. The only weapon that couldn't be lost that way was the basic machine gun... kinda annoying to lose a weapon that you bought in-game like that, though... well, it would be, if it were not for the fact that, if you've gotten to that level of health in Raptor: Call of the Shadows, you are very likely to not be alive about 10 seconds later, and at that point, it doesn't really matter what weapons you have any more anyways. XD Still, I think that just DISABLING the weapons (one at a time, or all at once, it's up to you), rather then making the player lose them entirely, would probably be a better solution for a game like yours.

I like the sound of this kind of dynamic approach to shields. I think it could be made to work in a more arcady game, though you'd have to be very smart about it (signifying every step very simply and succinctly to the player, in a way that's impossible to miss in the heat of battle, without being too obnoxious)

I think this bit sounds problematic though:
"As the ship's weapon system is damaged its damage output is reduced"

That basically turns the enemies into bullet sponges, which is rarely fun. Maybe instead of lessening damage, the accuracy can instead be compromised (with a little randomisation added to your bullets), and maybe even some involuntary ship movement and/or camera shake. As punishments go, that one seems more 'adrenaliny' and fun to me. Another benefit is that it's more visual in nature (unlike reduced damage which is just a change in an invisible number). More visual is good, since it contributes to gamefeel, and better signals what's going to the player.

Another benefit of your accuracy going screwy is that it provides the potential for the occasional 'lucky shot', which is the sort of thing that always feels great to the player when it happens.

Yeah, but there are better and worse ways of making enemies harder. The bullet sponge method often annoys people because they see it as lazy design. You often see players complaining on forums that a game's "hard" setting is nothing but extra HP for the enemies. Those players want a harder game, but they'd rather see the enemies get more devious AI, more numerous enemies with organised group behavioue, newer types of attacks, etc......rather than just an increased hitpoint number.

Sounds like you're not taking the lazy road though, which is good. Though I'd still question the design logic of damage reduction in your case, because if not treated carefully, it could become a fairly meaningless mechanic. If the player is being overwhelmed by enemies and almost about to die, reducing his damage output is just making the climb even steeper, and greatly increasing the odds that he dies. You may well get the situation where the player learns that there's barely any point bothering to play after the guns have become weak. If that happens, then the mechanic has achieved little more than shifted the "death" event forward: instead of being dead when you have 0% health, you're [more or less] dead when you have 10% health [or whatever % your guns become weak at].

If you've ever played the Borderlands games, you know that the absolute #1 most exciting and tense moments are those where you're in Fight For Your Life mode (after you 'die' the game gifts you a bonus 10 seconds or so with limited mobility but your normal guns where you can defeat death by frantically finding and killing any enemy). That's a truly excellent piece of game design right there, but for it to work, and the player to really feel the tension, two things must be true:

#1 - death is imminent and very possible
#2 - avoiding death, while challenging, is also very possible

Without either of those, the mechanic would be boring and without tension. Without #1, it'd be a farce. But without #2, there'd be little incentive to bother playing after you get downed.

in Star Wars they sometimes mention diverting power from 'x' to or from the deflector shields.

So what if, you could balance the amount of power your shields have with how much firepower you output? so if you're getting pummeled by heavy fire, divert power to your shields, if you're on the attack, divert power to your blasters at the expense of your own defenses.

Depends on the game and target demographic, I guess. That kind of regenerative health mechanic is often looked down on by retro purists. But I personally think regenerative health can be a really great mechanic, because it tends to make for dynamic gameplay. It encourages bold play, but only within reason, and it forces you to frequently switch between being on the offensive to being on the defensive (while your shields are recharging), which can make for an exciting cat-and-mouse dynamic. It also tends to focus the gameplay on individual battles and skirmishes, and allows the player to approach each new skirmish with full health, which I think is a good thing.

I really like the idea of overall regeneration speed being lowered every time you take damage. That's kind of the best of both worlds: the dynamism of regenerative health, but with an element of permanence and consequence

FWIW, Enemies becoming bullet sponges (or sorts) in Castle Crashers is why I no longer play that game anymore.

I like the random chance of bullet targeting to be off when the weapons are damaged though.

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Regenerating health isn't the best idea in a lot of games because the player can always just go off to a safe place and heal up and it might get boring. But in a game like yours, with no safe place to retreat to, I think this is a great idea. Plus it'd reward a player for not getting hit.

Something some people don't seem to realize is that there are even Retro games with regenerative health mechanics, the previously-mentioned-by-me Tyrian being a good example (and Mega Man X3 technically had it as well, and it was actually pretty annoying in that game I have to say). Sure, it was only the shield that regenerated in Tyrian, but I'd say that Tyrian did so much of a good job of handling such a system, I don't see it being a problem if handled right in other games...

In Tyrian, for example, it wasn't as simple as just sitting around letting your health regenerate, since there were enemies attacking you pretty much constantly. In order to regenerate health, you had to keep dodging constantly, and you also couldn't fire much while doing so since that would eat through your energy supply so fast that you can't fire OR regenerate shields effectively with later-game weapons, at least until you get a late-game generator to go with it (which you get significantly later then the later-game weapons in question).

Well, if there IS to be a regeneration mechanic, that sounds like it could be one way to make it work.