I think the Japan dev's were just caught and now surpassed by the western world. If you think back to the PS1 days, the defining games were your Final Fantasy's, MGS's, Resident Evils, Tekken, Gran Turismo etc. The Western world just didn't make games that competed with those either graphically, in terms of scale or in terms of quality. The few that did sold fine - Crash Bandicoot / Tomb Raider - but they were pretty much the exception to the rule.
But now when you look at the games which seem to have the greatest scale, the best polish etc it's all western stuff, Batman:AC, Skyrim, Mass Effect, Assassin's Creed, COD etc. The 'old guard' of Ps1 Japan big hitter still sell here (Albeit all at much lower levels now) but Japan isn't creating much new on consoles that imo can be put next to western games.
Nintendo still create amazing content that sells by bucketloads though. I think Japan has had a lot of it's investment go into handhelds as well, which most of the western pubs ignore, which has hurt a bit.
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