My personal experience, having lived in Japan for nearly three years:
Previous generations were bigger because the number of children, teens and people in their 20s was much bigger. It's mostly just a demographics issue.
Unlike in Western countries, where adults seem to keep playing games, most Japanese adults seem to give up on it as soon as they find a job with a permanent contract. They simply have no time to play games anymore, because many people work insane hours and are 100% dedicated to their jobs, and the little time they get they often need to spend with their families. Hence handheld gaming grew exponentially as home consoles declined, those teens became adults and now played mostly on the train. Now that everyone has a smartphone, that is replacing handheld gaming too, because it's more convenient for most people. Japanese people are obsessed with "convenience". Seriously, you'll hear that word here all the time.
Other smaller factors: many adults seem content with replaying old games from the NES-PS2 era, and don't much care for better graphics. Retro gaming is really big here. Another thing I often get is people saying modern games are too "difficult", which is funny because most people would say otherwise, so I think they mean "complex".
As for your arguments on the Japanese industry, it might be true that Japanese output has declined, but that's also to do with there not being too big a market and games becoming expensive to make. However, I'd like to point out that many teens and kids are way more interested Western games than adults, Actually, most people I know with PS4s are fairly into Western games like GTA, CoD, Battlefield or Minecraft. Those are definitely the top 4, but there is more buzz for Western games in general among the core gamers left. Those people also seem more willing to buy PS4s right now.
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