"Tonight we have two types of cocaine; normal for 100 Bolivianos a gram, and strong cocaine for 150 [Bolivianos] a gram." The waiter has just finished taking our drink order of two rum-and-Cokes here in La Paz, Bolivia, and as everybody in this bar knows, he is now offering the main course. The bottled water is on the house.

The waiter arrives at the table, lowers the tray and places an empty black CD case in the middle of the table. Next to the CD case are two straws and two little black packets. He is so casual he might as well be delivering a sandwich and fries. And he has seen it all. "We had some Australians; they stayed here for four days. They would take turns sleeping and the only time they left was to go to the ATM," says Roberto, who has worked at Route 36 (in its various locations) for the last six months. Behind the bar, he goes back to casually slicing straws into neat 8cm lengths.

La Paz, Bolivia, at 3,900m above sea level – an altitude where even two flights of stairs makes your heart race like a hummingbird – is home to the most celebrated bar in all of South America: Route 36, the world's first cocaine lounge. I sit back to take in the scene – table after table of chatty young backpackers, many of whom are taking a gap year, awaiting a new job or simply escaping the northern hemisphere for the delights of South America, which, for many it seems, include cocaine.

"Since they are an after-hours club and serve cocaine the neighbours tend to complain pretty fast. So they move all the time. Maybe if they are lucky they last three months in the same place, but often it is just two weeks. Route 36 is a movable feast," says a Bolivian newspaper editor who asked not to be named. "One day it is in one zone and then it pops up in another area. Certainly it is the most famous among the backpacker crowd but there are several other places that are offering cocaine as well. Because Route 36 changes addresses so much there is a lot of confusion about how many cocaine bars are out there."

This new trend of 'cocaine tourism' can be put down to a combination of Bolivia's notoriously corrupt public officials, the chaotic "anything goes" attitude of La Paz, and the national example of President Evo Morales, himself a coca grower. (Coca is the leaf, and cocaine is the highly manufactured and refined powder.) Morales has diligently fought for the rights of coca growers and tossed the US Drug Enforcement Agency (DEA) out of Bolivia. While he has said he will crack down on cocaine production, he appears to be swimming against the current. In early July, the largest ever cocaine factory was discovered in eastern Bolivia. Capable of producing 100kg a day, the lab was run by Colombians and provided the latest evidence that Bolivia is now home to sophisticated cocaine laboratories. The lab was the fourth large facility to be found in Bolivia this year.

Nowhere in South America is cocaine production growing faster than Bolivia. Reports by the UN show that in Colombia, production dropped 28% last year [2008], while in Bolivia it rose nearly 10%. "There is more interest and and investment in purifying coca paste here and exporting it, rather than sending it to Colombia for purification," Oscar Nina, Bolivia's top anti-drug official, said recently.

As the US and Colombian military put pressure on drug traffickers, operations are migrating into nearby countries, especially Bolivia, where the turf for illegal operations is as fertile as the valleys where the locals have grown coca for the last five centuries. Stopping cocaine tourism in La Paz could be as difficult as keeping Americans from drinking during prohibition.

Down in Route 36's main room, the scene is chilled. A half-hearted disco ball sporadically bathes the room in red and green light. Each table has candles and a stash of bottled water, plus whatever mixers one cares to add to your drink. In the corner, a pile of board games includes chess, backgammon, and Jenga, the game in which a steady hand pulls out bricks from a tower of blocks until the whole pile collapses. If it weren't for the heads bobbing down like birds scouring the seashore for food, you would never know that huge amounts of cocaine were being casually ingested. There's a lot of mingling from table to table. Everyone here has stories – the latest adventures from Ecuador, the best bus to Peru – and even the most wired "why-won't-he-shut-up?" traveller is given a generous welcome before being sent back to his table, where he can repeat those stories another 10 times.

"Everyone knows about this place," says Jonas, a backpacker who arrived two days earlier. "My mate came to Bolivia last year and he said, 'Route 36 is the best lounge in all of South America.'" It is certainly the most bizarre and brazen. Though cocaine is illegal in Bolivia, Route 36 is fast becoming an essential stop for thousands of tourists who come here every year and happily sample the country's cocaine, which is famous for both its availability, price (around €15 a gram) and purity.

The scene here is peaceful; there seems no fear that anyone will be caught. ("The owner has paid off all the right people," one waiter says with a smile.) A female backpacker from Newcastle slips on to one of the four couches arranged around the table. "We've brought some [cocaine] virgins here. This will be their first time, so we are just rubbing it on their lips. But they are lucky – you could never get such pure coke back home. In London you pay 50 quid for a gram that's been cut so much, all it does it make your lips numb and sends you to the bathroom."

Travellers' blogs also give the place a good writeup. "I travelled the world for nine months, and for sure La Paz was the craziest city and Route 36 the best bar of my entire trip," writes one, while another says, "Like to burn the candle at both ends? Well, here you can bloody well torch the whole candle."

And torch your brain as well. Cocaine, as everybody knows, is highly addictive, destructive and easy to abuse. The rationale for outlawing cocaine was to protect public health – but instead the now 40-year experiment in prohibition has done little to protect the lives of millions of users worldwide who will snort whatever white substance is placed before them. The billions in annual profits have corrupted governments worldwide, and La Paz, without intending it, seems to have mutated into the front line of this failed drug war.