Functional literacy has a fairly simple denotation: the ability of someone who is literate in a language to apply that language to normal life tasks. The connotation of functional literacy, (and therefore of functional illiteracy) are somewhat more complicated.
As I have mentioned before, the educational system in the United States (and elsewhere) is often a frequent target for alarmism and rebuke, and the statistics on functional literacy (or its complement, functional illiteracy) are often cited as part of that. Often the distinction between literacy and illiteracy is lost, especially in the popular press.
First, a statement about simple literacy and the American population. According to the CIA World Fact Book, the level of literacy here is 99% (although I suppose it is only including those who are mentally and physically capable of reading), which is the same as any other developed nation. Of course, the simple ability to translate written words into spoken words does not mean that people are able to understand and use that information. And that is where the complication about functional literacy begins.
The basic study referred to is the National Asssessment of Adult Literacy, a very large study covering large cross sections of the adult population. For more information than I can probably give,
http://nces.ed.gov/naal/
has a full description of the studies across years. But one thing should be pointed out, that the test is not a test of simple literacy. It is a test to see whether someone can draw information out of a number of diagrams, and charts, and whether they can analyze the main point of passages. It is a test of critical and analytical thinking,not a test of what is usually considered literacy. Some of the questions that can be found on the page seem to be
trick questions, as when an
almanac lists information in chronological order, with most recent on the left to least recent on the right. In addition, some of the questions seem to be somewhat open to interpretation, as when the tester must explain the meaning of an
Emily Dickinson poem. Many of the questions are questions I could imagine missing, especially if I was not that motivated in the test, and decided to not give questions about
sandpaper use my full attention.
While I don't doubt that many literate Americans are unable to totally use their basic skills in application to their life, taking the tests of functional literacy at face value is probably not the best way to analyze and assess the problem, especially when it passes through the media, folklore and joins into the Saturday Night Live syndrome of declining academic ability in the American populace. I also find it ironic (and somewhat of a paradox) that one of the definitions of functional literacy is the ability to critically examine something being read, and that the people who read and repeat things like "30 million Americans are illiterate!" are among the illiterates they are in contempt of.