The rise in developement costs isn't something inherent to improved hardware. It's more due to the fact that you have to make a better product to take more marketshare - something best highlighted in the NES days. Nintendo made the best games, which clearly had the highest 'budgets' and they dominated the software sales charts. Companies had to spend more to compete. Same thing in the PS1 days - the games which dominated sales were those with the highest budget. Throw in the fact that marketing budgets have exploded and you get the 9 figure game budgets we see today.
Costs go up because companies are greedy - they want to sell more then everyone else. When Activision spent $200m marketing Modern Warfare 2 - they sent out a message saying to other publishers 'you can either spend as much as us, or not bother competiting with us' - most games were delayed until the new year. This is why costs go up, because companies have to compete - yes new hardware means they're spending more on art assets and whatnot, but it's not the new consoles that really the reason. It's the fact that if your game isn't in the 'top tier' it wont sell.
Will the industry survive? Yeah definitely - in all honesty I think for the guys at the top it'll thrive. We've already seen it quenching innovation in big budget games though and the 'middle tier' of game developement is dying, but as a whole I think it'll be fine. There are worrying trends associated with the rising costs but at the same time the idea that companies werent trying to make the best game possible would be more worrying - even if some of the guys who arn't good enough go bankrupt.
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