A Romanian government commission set up to combat widespread corruption in the international adoption business, and the suspected maltreatment of children and babies, has uncovered a "catalogue of horrors", involving global child trafficking rings, drugged babies and stolen identities.

Thousands of Romanian children placed in orphanages set up by the late communist dictator, Nicolae Ceausescu, are believed to have been trafficked abroad by criminal gangs in the past 12 years. In many cases adoptions had "given oxygen and life blood" to gangs linked to terrorist organisations, according to the commission.

Police are investigating at least 50 cases of handicapped and older children who were taken to South America and have since disappeared. Several arrests have been made in the past few days and others are due to follow.

But it is feared that as many as 500 victims across western Europe and the United States may never be traced and that many children have ended up in prostitution and slave rings, said Lady Nicholson, the European Union reporter for Romania, who is chairing a high-level group to which the commission will report.

The commission was established following fierce criticism of the country's childcare system by Lady Nicholson, a Liberal Democrat MEP and former president of Save the Children.

She sparked a public debate in May with the publication of her report into the system, in which she cited "persistent abandonment of children, child abuse and neglect" and "child trafficking", adding that the "fundamental rights of children have been widely abused in Romania in recent years".

Lady Nicholson said that the country's childcare system was corrupt "from top to bottom", and recommended that Romania be excluded from the accession process to the EU - which it is desperate to join - if a thorough investigation and overhaul of the system failed to take place.

"With this reform programme Romania has started to turn the corner in its treatment of children for the first time since world war two, but in so doing we're uncovering more and more horror," she told the Guardian on a visit to Bucharest.

In its first few weeks, the investigative team has uncovered cases in which Romanian mothers unwittingly gave up their children, who subsequently joined the adoption pipeline.

"We know of cases where mothers had babies which were declared dead after birth. The mothers were shown blue babies, believing them to be dead or dying," Lady Nicholson said. "We have evidence that the babies were injected by the doctors and then taken away, where they entered the global adoption market."

In some cases children's identities were swapped or stolen. In others Romanian couples were denied access to the adoption system because they were unable to pay the high prices that western families could afford.

Romanian children are regularly "sold" through official channels for an average price of £35,000. Under Romanian law a substantial amount of the money is meant to be pumped back into improving the childcare system and to finance the closure of hundreds of children's homes. But the investigation has found that in many cases the money has gone to middlemen and officials "at every level".

The commission has discovered that more than one-third of the almost 60,000 children placed in remote special schools for the handicapped had only "trivial" disabilities, such as harelips. They have since been removed and are awaiting placements in homes or with foster families.

Lady Nicholson successfully lobbied for a one-year moratorium on international adoptions of Romanian children, introduced in June, leaving 3,500 couples who were in the process of adopting in limbo.

Romania's social democrat prime minister, Adrian Nastase, has launched a detailed reform programme which involves working towards closing many of the decrepit and poorly run children's institutions and setting up a police and prosecution team.

Border controls have also been tightened in an attempt to stem the flow of child trafficking, said by Interpol to be the fastest-growing sector of organised crime.

Yesterday the government pledged to work hard to "accelerate the closure of the most urgent cases of children in limbo", and added in a statement that it was committed to building an "efficient, transparent and legal system of adoptions... and to eliminate corruption".

Mr Nastase said: "The moratorium gives us time to prepare better legislation and find a solution to the international adoption problems."

Because of poor record-keeping it is not known how many international adoptions of Romanian children - legal or otherwise - have taken place since the fall of communism, although experts say 60,000 is a "conservative estimate".

Since the moratorium, the number of national adoptions has doubled, according to Lady Nicholson, proof, she says, that international adoptions should not be seen as the only solution to parentless children. A national fostering programme started in 1997 has found homes for 7,000 children.

"I refuse to believe that a country of 23m cannot absorb 60,000 children and we need to encourage this," she said.

But others disagree. "There is not the capacity or the means in Romania," said Maria Stefan, adoption coordinator for Bethany, the biggest US adoption agency for the country. "Many families are disappointed that they can't adopt, and the children are also being forced to wait."