The world of faerie co-exists with our own, and has its own moral measure. What we consider good and evil--events we judge based on our own societal and personal calculi of tolerability--will have an entirely different significance for fauns, nymphs, and faeries, if they have significance at all. Immortal beings of course have a broader context in which to situate the daily news.
Pan's Labyrinth is only briefly about the realm of faerie, at least in a comparative sense. Most of the film is about fascism in Franco's Spain. The narrative features a truly monstrous Captain, a creaking leather sadist, whose task is to destroy a band of Republican guerillas holding out in the hills around an old mill. The Captain brings his pregnant wife and her young daughter by a previous man to the mill. Nearby is the mysterious stone edifice from which the film gets its title. This labyrinth instantly attracts young Ofelia, the heroine of the film, and the one character who inhabits both its worlds.
There's a lot to say about this masterpiece, but without spoilers I'd be hard-pressed to discuss or describe it. Guillermo del Toro does a magnificent job balancing its two plots, and providing the viewer a comparison/contrast between what we'd consider a gruesome realm of fanciful monsters and magic and an even more monstrous reality. Unfortunately the worse of these two worlds is not a bit unbelievable.
One caution. Don't take the kids to this one. Some scenes were too horrid for my poor wife, who squirmed and covered her face. The people next to me were disgusted. There are torture scenes, and a homicide that pays homage to the most horrifying cinematic killing I've ever seen (from Gaspar Noe's Irreversible).
Nevertheless, I was enchanted the entire time. This one goes in the DVD library upon its release.