Speaking at the re-opening of a school at East Malvern in his Melbourne electorate of Higgins, Mr Costello said the Democrats was established by the late Don Chipp as an offshoot of the Liberals, but swung to the left in the 1990s.
"I think the retirement of Senator Stott Despoja really closes the chapter for the Australian Democrats, opened by Don Chipp, closed by Senator Stott Despoja," he told reporters.
"The Democrats found a role as a centre party in the 70s, the 80s, but then they decided to take themselves off onto a more left-wing basis.
"They found themselves outflanked for that ground by The Greens. They were a response to a historical time. That time has passed and they have passed."
End of an era
Senator Stott Despoja announced yesterday she would not contest the next federal election so she could spend more time with her family.
The retiring senator has rejected claims she was too young to lead a beleaguered political party.
"To this day I will always promote experience over age and I was the most experienced person in a political and legislative sense in that party room," she said.
"Maybe some people found that uncomfortable, having someone relatively young in that position, but it wasn't about age. Yes, it was a divided party room. There is no getting away from that.
Senator Stott Despoja was just 32 in April 2001 when she was elected Democrats leader after successfully challenging former leader Meg Lees.
She stepped aside as leader in August 2002 after a tempestuous term.
"I guess if I had one regret it was the inability to unite that party room.
"But in order to unite a fractured and divisive party room, you need willingness on all sides and that didn't happen and so I did what was the right thing for the party and the party room: I stepped down."
But Senator Stott Despoja said she was very proud of her time as leader.
"No one is perfect in that position but in 2001 we came back with four senators, re-elected against the odds," she said.
"It was a pretty tough period for us in the polls after the GST decision. I don't think anyone, any punter or commentator disputes that now.
The retiring Senator said she believed the Democrats' decline stemmed from a variety of causes including competition from other minor parties and support for the government on the GST.
She said their research revealed that that was a pivotal reason for disenchantment because of a perception that the party keeping the government honest had broken promises.
"That is something that I am very sad about to this day," she said.
"But certainly internal issues never helped.
"But let's look at the good stuff. Over almost 30 years our legislative record is extraordinary and I hope that Australians recognise that we need that more than ever."