This is a small quirk I have seen in Windows XP (several) times now: inability to drag and drop files (or icons) in the Windows XP user interface (Windows Explorer or the desktop. What causes it? Sometimes has to do with installation of new hardware (particularly mice), sometimes may follow installation of new registry editing software, sometimes the cause is unknown.
Here's a good solution that has worked for me every time now:
Create a backup of your registry! :)
Copy the text from the code box (below) into an instance of notepad (or another pure text editor).
Save the text as "dragdropfix.reg"
Double click on the file in Windows to merge it with the registry.