In the beginning of Discipline and Punish: Birth of the Prison, Michel Foucault describes the public torture of an attempted regicide in the mid-18th century. The extreme and spectacular way in which this man was humiliated, brutalized, and killed typifies, in Foucault's view, the pre-modern logic of punishment—that is, punishment as spectacle, or a public re-assertion of the total ruler's power (in this case, the French King).
Next, Foucault argues that such spectacles of punishment have been replaced, in modern nation-states, with a mode best encapsulated by the notion of the panopticon. The panopticon is a prison designed so that a prisoner can always be seen, but cannot see the warden. The prisoner is aware of the warden's presence; he is also aware of his own ability to see that person, who could be anywhere, at any time, ready to dispense his awful power. Hence, the prisoner will police himself; he internalizes this (hidden, yet so very palpable) panoptic power. He will "behave" even in the (visual, physical) absence of those who imprison him.
This transition—from pre-modern to modern, from spectacle to panopticon—is linked to, and necessitated by, the emergence of nation-states. In pre-modern times, entire populations were, in Foucault's terms, illegible; their lives, deaths, and activities were quite unknown to ruling elites, who had no need of such information. Of what interest would the health of a peasant be to a (divine) French King, safe in his opulent, well-guarded castle?
All of this would change with the rise of nation-states, which, by definition, require bureaucracy, order, and (well-kept, in-depth) knowledge. Let's take, for example, a budding nation-state whose wars demand a standing army. In order to consolidate such a group, government officials, bureaucrats, and military generals would have to know the following:
1) The total number of young, healthy men in the country
2) The total number of generals, or otherwise experienced men, available to train these new recruits
3) The availability of weapons, and machines with which to build them
4) The cost of such weapons
5) The nation-state's capacity to build such weapons (in factories, and so on)
6) The amount of skilled workers needed to run these factories
7) The type, and scale, of education needed to train these workers
These figures, if collected, would constitute only a tiny fraction of the information needed to create and maintain a standing army, much less engage in trade or diplomacy with other nation-states. We see that, in order for a nation-state to thrive, or even exist, it must collect information; it must render all of its assets, human and non-human alike, legible and ready for use.
Thus, modern governments collect and store data in the form of birth, death, and public health records; they also build schools, hospitals, prisons, all of which constitute, for Foucault, the "panoptic society" in which citizens police themselves. Gone are the days of the public torture-spectacle; they have been replaced by the hidden, palpable, and nearly omnipotent power of the panoptic society.
Foucault's notion of the panopticon is incredibly powerful in the sense that it shows how modes of punishment and power can change in response to broader social transitions (that is, the transition from pre-modern to modern, from secluded village to bustling city). It also helps us conceive of how power is distributed throughout society, and how individual people respond to (and internalize) that power.
Critics, however, have pointed out that Foucault's discussion of the panoptic society does not explain how, and why, that society often fails to subjugate its citizens. There are always rebels, criminals, and countless other people who challenge the status quo, and who even succeed in toppling institutions. Clearly, the panopticon is not as all-seeing as it—or Foucault—believes.
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