Can you use automatic prepaid return labels if the return requires an approval?

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Absolutely. Just for a little background: each return has a lifecylce (pending, approved, shipped, received, resolved, rejected) and each stage in this lifecycle has an associated email that (can) be sent out to the customer automatically.
So in this case with automatic prepaid labels where returns have to be manually approved:
1) customer completes a return - return is in "pending" state - receives the email for "pending"
2) your staff approves the return - return moves to "approved"
3) label is created and sent out to the customer with the "approved" email
4) and so on..
If returns are auto-approved (see the settings for enabling/disabling auto-approval under the Return-Settings / General tab) then the label is created immediately, the customer sees the label as soon as the returns process ends and receives the label in addition via email.
If the return requires approval first, the label is only created when the return is approved by staff and only then sent to the customer via email.