AI and physics are what I'd like to see improve. Not with meagre scraps of power left over from frame rendering, but as a priority, as pillars of game design rather than afterthoughts.
Pretty pictures do not immerse me in game worlds. A photorealistic but completely static game world with stupid predictable AI does not interest me one bit. I can flip open my phone/tablet and browse pretty images or go on virtual tours all day long. I don't want to. I want to interact with my games and have them interact with me.
A game with interesting physics interactions (not necessarily realistic - exaggerated/wacky physics are perfectly valid choices) and wiley, challenging AI gets my attention and holds it. This also provides opportunities for emergent gameplay, and makes for replayability.
There are many games I just can't be bothered to play anymore due to dumb AI. CoD campaigns for example. Cod controls great, runs fluidly, and has mostly decent encounter design. The possibilities for challenging, dynamic, unpredictable combat are huge in those games. However most of the time for any given scenario I can sit in one place and play whack-a-mole with AI that can do little more than pop up from cover and occasionally shift position. Yaaaaaawn.
Halo does AI better than any shooter out there. Enemies are clever, not just individually but in groups. Enemy command structure can also be exploited by the player. Take out a squad leader and grunts panic and will retreat and regroup. There have been papers written on Halo's group AI. It's one of the few games where higher difficulty levels do not simply mean more enemies or higher hitpoint enemies. A legendary difficulty Elite is hard to kill not just because of how strong it is but because of how well it manages it's recharging shield by using cover, and how well it can pressure you when it knows your shields are low.
Another standout example of AI in games recently is Forza with the Drivatar system. Racing against real people is unpredictable and fun because of a clash of driving styles. Many racing game career events simply have a procession of cars plodding along the racing line with little variance and little to no awareness of other racers.
With the Drivatar system the basic models of AI are modified with real peoples racing telemetry, imparting 'flavor' on AI opponents. It's great seeing AI opponents having little duels, or totally ballsing up their braking zones like the real owner of the Drivatar (me in the case of braking zones!) would.
Battlefield:Bad Company achieved unpredictability and replayability through a great physics engine. Having destructible environments, even in BFBC's slightly limited fashion, multiplied the number of ways each encounter could be approached. Red Faction:Guerilla did a great job of destructibility too and produced loads of surprising and fun encounters. Completely unscripted and unique for each player.
Screenshot warriors/pixel counters/digital foundry and it's braying hordes of 'number enthusiasts' are why the games industry is in such a rut IMO. AAA developers, those teams with the resources to really push gameplay systems, oftentimes cannot do so due to the ridiculous backlash that comes with any game that isn't putting every last drop of horsepower into resolution and image processing. It's saddening.
I hope that cloud computing really takes off, partly because it really isn't applicable to generating billions of shiny shiny pixels so might actually get put to good use. AI and physics will benefit hugely from cloud computing. Hopefully Crackdown will be a good example of large-scale cloud enhanced physics.