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I took the OP's question as one of asking "among the subset of games which tell linear narrative stories with plots, characters, dialogue etc., have these stories declined in quality over time?" I think that's a fundamentally different question to the question of whether games without such narratives have improved or declined in quality. In Frostpunk, there is no "narrative": the narrative is the player's experience in the game, enabled by the mechanics. It's the difference between a novel and a DnD campaign. Everyone intuitively understands that Frostpunk is trying to do something fundamentally different from what Call of Duty is trying to do, at a mechanical and experiential level - it's confusing that "success" in game design is invariably described in reference to how "fun" the game is, when this descriptor hides more than it illuminates.
And maybe this is part of the story: maybe at the start of the PS4 era, all the smart game designers in the indie space collectively realised that trying to use video games to tell stories the same way that books or films do was a lost cause, and focused instead on crafting organic, player-directed simulations with more intuitive interfaces and better production values compared to their 90s forebears. This would mean that the last ten years of AAA games still doing the lame "Hollywood action movie but you're the main character" thing isn't evidence that video games have lost their way or are on the verge of another crash: it just means that the lumbering AAA game studios haven't cottoned on to the new hot trend, which is intentionally narrative-light organic player-directed simulations. If this were the case, it would be a fascinating narrative to describe the last decade and a half.
There is also the issue of budgets. It costs more and more to make a video game. How big did a studio need to be to make a JRPG for the ps2 vs how big does it need to be for the ps4. As it gets more costly to make a console game the harder it is to justify taking a risk on an interesting narrative. I loved Specs Ops: The Line and I maintain that it's the best way to read Heart of Darkness. But I simply can't imagine it getting made in this environment.
PC gaming is getting better and better though, if only through accumulation over time. And if you consider visual novels like Utawarerumono to count as video games then things have never been better. More top 5% of visual novels are out then ever before. I remember when it was regarded as an unprecedented victory when we got VNDB's 3rd most highly rated VN (Muv Luv Alternative), let alone the more obscure stuff, or legendary H games like the Rance series, Evenicle, or Dohna Dohna.
On a more narrative stories with plots, etc point we did get Disco Elysium, which was pure lightening in a bottle never to be regained. If you have not played it before it simply must be experienced. Suzerain may count, although it's characters are more expressions of political factions that exist and the real character is the nature of Turkiye post WW-2. But books have used individuals to express such situations for a very long time now.
Overall I think both your initial argument and your critique of my own are strong.
Perhaps it's that when graphics were bad and gameplay restricted that one of the only options left was to rely on strong writing. But now that graphics are good pretty much everywhere and gameplay design is a fairly well mastered craft there is just not as much pressure to perform on narrative. But that's just an intuition.
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