dd, device clone to smaller drive, no space left on device

dd does not know anything about partitions or any other structure on the disk. It doesn't recognize "allocated" or "unallocated" parts of the disk. From dd's point of view, a device given as parameter consists of a series of blocks. Thus, if you run dd if=/dev/sda of=/dev/sdb, dd will copy blocks starting from the beginning of /dev/sda to the correspondingly numbered blocks on /dev/sdb, until it has read all blocks from /dev/sda or until it hits an error. In your example, because /dev/sdb was smaller in size than /dev/sda, dd was terminated with the error message "No space left on device" (on /dev/sdb).