I am asking this question particularly with reference to solo guitar instrumentals and my experience with that idiom; though the question is relevant elsewhere. What I'm talking about specifically is SET solo arrangements - where there is no scope to improvise or make it up: the arrangement has to be played exactly as it is written. At opposite ends are: on the one hand, it should be played entirely from memory...whilst on the other, that it should be read as one plays. Now the first option is a great credit to the player and is in fact what I feel should happen. One should know a piece so well that one can then concentrate on putting it across. It isn't necesarily a good sign to see a player completely focussed on the written form as one plays. Perhaps it means they have not really learned it. So, yes, I think playing from memory is an ideal position to be in; and of course, there are strategies that enable this to happen: having the sound of the arrangement in one's head certainly helps; as does a complete understanding of the theoretical framework of the arrangement; though knowing the principal harmony that underscores it may be sufficient. Having said that, from my own experience, it is possible to learn to play an arrangement without anything but a memory of shapes, patterns, positions and fingering. Depending on different factors, that might even be enough; but it still helps to have the sound and the theory.
However, I feel there are times when playing solo arrangements from memory becomes a major feat; especially if the programme is any of duration: playing piece after piece purely from memory is like walking a tightrope without a safety net. Precarious! It just takes one distraction or one slip and sometimes one is lost. Completely...because of the way it was learned in the first place perhaps: by rote. In any case, I feel that whilst playing from memory using various strategies is a good thing, it makes a lot of sense to have the written music in front of you.
Is there any merit in learing to read and play at the same time? Well, perhaps but enough exposure to a piece means that most of it gets memorised anyway and just reading is not always a good sign.
What I would suggest is practising a situation where the music is in front but one plays from memory. Then when it goes wrong or a slip happens, one can look at the music. Sure...but the name of the game is to not have to stop or interrupt the music. So...if one had been playing from memory to the point where one forgets what to do next...then how long does it take to look at the music and be reminded? I think this is something that needs to be practised - this safety procedure. In fact, for the sake of that, one should practise reading as one plays, not taking the eyes off the sheet music. This is a good fallback position to have if the memory fails. Obviously it becomes harder the more position changes there are on a guitar; so perhaps one can work out where in the piece the hands need to be looked at.
It is said that you are what you eat; and it is equally true to say that you are what practise: in practise, we need to address issues or possible issues. The worst thing would be to have perfect practise sessions where nothing goes wrong...because one needs to learn to deal with it in a real situation; so it needs to be rehearsed.