On POSIX platforms, the function is called in the child after GLib has performed all the setup it plans to perform, but before calling exec(). Actions taken in this function will only affect the child, not the parent.
On Windows, the function is called in the parent. Its usefulness on Windows is thus questionable. In many cases executing the child setup function in the parent can have ill effects, and you should be very careful when porting software to Windows that uses child setup functions.
However, even on POSIX, you are extremely limited in what you can safely do from a GSpawnChildSetupFunc, because any mutexes that were held by other threads in the parent process at the time of the fork() will still be locked in the child process, and they will never be unlocked (since the threads that held them don't exist in the child). POSIX allows only async-signal-safe functions (see signal(7)) to be called in the child between fork() and exec(), which drastically limits the usefulness of child setup functions.
In particular, it is not safe to call any function which may call malloc(), which includes POSIX functions such as setenv(). If you need to set up the child environment differently from the parent, you should use g_get_environ(), g_environ_setenv(), and g_environ_unsetenv(), and then pass the complete environment list to the g_spawn... function.