Great discussion!
I like the comparison with a magical late Middle Ages/slightly pre-Renaissance Europe. It makes sense that magic and wizardry provide an outlet for creative engineering tinkerers, therefore physical technology is vastly under-developed (and outclassed!). I'm going to need to cogitate some on the long-range consequences of this assumption... I'd love to hear your experiences on the subject!
I think that in order for literacy to be truly widespread, there would need to be some magical equivalent of the printing press. Manually scribing books is simply too long, costly, and tediously boring for it to persist in a magically empowered world. I'll see if I can't make a low-level cleric & wizard spell for copying mundane text relatively easily and cheaply. (I'm actually thinking of Rita Skeeter's Quick Quotes Quill from Harry Potter - it's a quill that automatically writes what it hears (sort of). It's a fun mental image!)
I can accept the fact that adventurers are not normal people by definition, so it isn't too huge a logical leap to arrive at the conclusion that they ought to know how to read.
Reading and writing is basically a trick that you learn once, and ever after you can apply the principle to whatever languages you learn. In that light, I think that I might make Literacy a virtual feat that PC classes possess. There is a pre-requisite though: for any given character to be literate, the player needs to explain to me how their character learned to read. NPC and barbarian classes do not have the virtual feat, but they can learn it by burning a feat on it. Anything that gives me more plot hooks can't be a bad thing!
I actually have a bit of a bone with the Speak Languages skill as well. It simply doesn't reflect the difficulty of learning languages, as far as I'm concerned. Speaking is one thing, but reading a language is something completely different. If you've learned Chinese, you know what I'm talking about. I'm thinking of adopting the following modifications to the skill:
1) It costs 1 rank of Speak Languages to learn to speak (only) a language.
2) It costs one rank of Speak Languages to learn a given alphabet. This doesn't mean you can read the language, just that you've learned the alphabet.
3) It costs one rank of Speak Languages to learn to read a given language. This obviously requires knowledge of the alphabet first.
An interesting side-effect of this is that you can learn to read a language without knowing how to speak it. (Hint: think Ancient Egyptian or Sanskrit.) The fact that it costs more skill points to learn a language is a good thing, in my books. I like granular language abilities.
-blarguage