Click wheel "coating" wears out over time
Yes, my iPod Photo 40gb started developing problems with its click wheel about a week ago. The sensitivity fluctuates, making the click wheel unresponsive. It seemed to have a "dead zone" in the lower left hand quadrant.
From what I've been able to piece together on the web, this is not uncommon and will probably afflict all click wheels eventually as the protective "coating" on the click wheel surface wears out. (I don't fully understand the mechanics, but the coating allows the iPod to sense the difference in capacitance between the air and your finger.) I found several fixes:
(1) Toggling the hold switch will "recalibrate" the click wheel, restoring response temporarily. NOTE: This is not a permanent solution.
(2) Replacing the click wheel, which requires disassembly of the iPod. Certainly doable and a permanent solution, but not for people who aren't experienced at repairing small electrical devices. If you've ever replaced an iPod battery or hard drive, you should be able to handle this with little difficulty.
(3) Placing tape or a thin adhesive laminate over the click wheel. I tried by cutting a PDA screen protector to the size and shape of the click wheel, but it didn't work. The trick seems to be to make sure there are no air bubbles trapped under the tape, which can take patience and lots of re-tries to get it just right. My guess is that this would be a permanent solution and worth a try, but it didn't work for me.
(4) Painting the click wheel with clear nail polish. Sounds scary, but this appears to work. I used Revlon 771 Clear, but any clear nail polish should work. (Clear top coat finisher might work also, but top coat is designed to bond to wet nail polish and dries very fast. Sounds risky to me.) As I have no experience using nail polish, my attempt left a fairly lumpy, streaky coat on the click wheel. This doesn't seem to matter too much; the polish provides an air tight coating. The response is much better, although not as snappy and uniform as a new click wheel.
Hope that helps. I'd suggest trying the nail polish method first. It's quick, easier than fiddling with tape, and less expensive than buying a replacement click wheel.