Bleary, you asked "how do you then deal with the conflict that arises when a child brought up in this way goes into a world which by and large works on punishments".
I agree with aviatrix in that the home is not intended to be a microcosm of the world at large ie we don't recreate the same stresses at home so that the child knows what to expect when he finds his way around outside. If anything, it is the opposite: the home being a sanctuary and safe training ground for how to behave outside. We as parents don't have to make it any harder for our children. They know instinctively that the world is less forgiving.
Hence, my dd at 1+ was more obedient at nursery than at home!
I feel that the home should allow children to test boundaries and the full range of challenging behaviours in an environment in which they can feel safe. For this to happen, they should be allowed to express themselves without fear of harsh and arbitrary punishments (eg taking away a fave toy for hitting). But the role of the parent is to guide the child on what is appropriate and inappropriate behaviour, with the aim that the child eventually learns to empathise and internalise acceptable behaviour as a virtue in itself without extrinsic motivation, whether positive (rewards) or negative (timeout, etc).
It was certainly the case with me that when my parents used punishment, my focus was on how unfair it was (being hit by a bigger person) or how to avoid getting caught the next time. The message got lost in my feelings of resentment even though I knew they were right. As parents, we have a natural authority but applying arbitrary measures to enforce compliance detracts from rather than reinforces the message.
I hope I am making sense!