Games are getting better, imo. Or rather, on average they're getting better. My dad had an old atari, and while the only cartridges he kept were the good ones you could tell the difference. While you could tell the studios tried hard, technical limitations forced them to skimp on everything we love nowadays - gameplay, story, physics, graphics, etc were missing. All you had was an arcade game, with a backstory in the manual that was lost to time. At bare minimum, games have improved from the old days by sheer capability.
But even then, I'd argue games are getting better on average. Players expect more from a game, and the availability of information, even biased information, means that games with gaping holes in them don't do well. Anyone remember Fort Zombie, or Painkiller Resurrection? Nobody bought these games because they were unstable or just crap, and people reported such to the various forums and review sites. Game producers have to produce games that are at least worth the first playthrough or nobody will buy them. Meanwhile, the incredible titles pop up from time to time. Half Life 2 and Portal were awesome, Oblivion and Fallout 3 were both first rate for anyone who wasn't expecting a sandbox capable of dynamically creating the plot, Mount & Blade was an incredible sandbox game and has a very nice selection of mods, and let's not all forget our favorite game by the Toady One. Games on average are better, and great titles are still made. The reason people think the quality is declining is they compare a bread and butter title like the latest Call of Duty sequel to classic titles. If you compare the average to the best, you'll see it on the decline at all times.