This also explains a lot about the issues I had with the main campaign getting "corrupt" when trying to edit things in the toolset. It wasn't getting corrupt, the editor was just making folder trees for the files it couldn't locate. When the game ran it would then look into those empty folder trees instead of the pak files due to the priority order.
In addition, this gives me a very good idea of how dependancies and mods work. Basically, the pak files are kind of equivalent to the NWN "hak" files if anyone's ever done module building in that. The pak files contain things like textures, sounds, models, scripts, etc. So for example if you made a mod that puts in a custom sword, let's say the sword of 1000 truths, complete with a custom model. You would put the model, sound, texture files for this sword into an appropriate folder tree under the public dir. So for example you would have something like Divinity/Data/Public/FoodchainsNewSword/... and place approriate files into approriate directories. You could then make a module using the "Main" and "FoodchainsNewSword" dependencies and take assets such as trees from the Main campaign, and the custom sword you made into your own campaign.
It would be nice if there was a way we could pack our folders back into .pak files, but if worse comes to worse, we can just zip our packs and have users extract to the Public folder.
Very excited because this means we can do a whole lot of cool modding stuff for this game. Like adding custom music, sound, voiceovers, weapon models, player models, textures, trees, and so much more. Even making a custom character creation screen that supports 4 players should be fully possible.