I don't think it would end the arms race at all. I think there is room for both to do very well. I don't see the Wii slowing down for a long time. That does not mean MS or sony can not get off their butts get pricing under control. I think the 360 and PS3 can both be very profitable and do very well if they get pricing under control asap. I think a 100 dollar price drop and we would see 360s flying off the shelf with the fall line up MS has. The only thing that has screwed up HD gaming is the cost of blue ray and the adoption of HD-TVs.
Actually I think it will be a close race this time, but if Nintendo demonstrates that you can be competitive without the huge risk and upfront development costs of an advanced hardware platform, why would an MS or Sony take the risk with a PS4 or XBox720?
On the high dollar project front the argument is much the same, budget is fundamentally coupled to projected sales and ROI, and publishers will be willing to put more money in where there is a greater percieved upside. That doesn't mean genres will disapear, just that high budget titles will become less common in those now niche genres. When was the last time a company invested a lot in a 2D side scroller or a 2D shooter?