There's enough racism going on in the real world; do we really need racism in our fantasy? But there it is. Whether people are pointing out the differences between elves and orcs or exactly what horrible practices make the Evil Empire so evil, it's all about who's better than who because of ethnic affiliations.
Oz is surprisingly un-racist. While most of the heroes are Caucasian, no one is looked down upon due to their physical nature. The Cowardly Lion and Scarecrow were both valued friends of Dorothy during her original adventure and long afterward. The bad guys are never representative of their fellows. Ugu the Shoemaker was not a typical Herku. The Su-Dic of the Flatheads is more tolerated than loved by his people.
The most racist parts of Oz lore are incredibly tame. In "The Patchwork Girl of Oz", Ojo is subjected to a "ragtime" song in which the singer wails for his "coal-black Lulu". Later in the story, Dorothy, Ojo and company meet the Hottentots, who are playful little people who are intended to resemble African tribesmen. In the Books of Wonder edition of this book, "coal black Lulu" is simply "cross-eyed" and the Hottentots receive much less description and no illustration. Surprisingly tame stuff. I found "The Woggle-Bug Book" more offensive.
Racism does tend to turn up in the fantasy film industry quite often. Not in obvious ways, of course. Remember "Kung Fu Panda"? The backdrop was ancient China, the older characters (Po's father and the ancient kung fu master) had very Asian-sounding voices, but the hero of the film was Jack Black. Not just voiced by Jack Black, but the character was very much Jack Black, to the point of using the word (if word it be) "bodacity."
Apparently, someone in Hollywood thinks that we can't empathize with a hero unless he's "American." Notice that Jackie Chan is almost never the lone star of his American-made films. He is typically paired with an American actor, like Owen Wilson or Chris Tucker.
Some of you might be aware, the popular Nickelodeon animated series "Avatar: The Last Airbender" is being made into a live action film. Well, it seems that they're making a similar move, casting Caucasian actors in "heroic" roles while giving the villain role to an ethnic actor. While the characters are of different ethnicity on the show, it's nowhere near as glaring, as the two ethnicities are much more closely related.
Check out racebending.com for more info and the latest details on this controversy.