If its in 4wd at the switch but the propshaft still rotates by hand with four wheels on the ground the issue is in the tcase orwith the servo. The front end diff will not lock up until the tcase servo tells it to do so. Works this waywith that 4wd-auto crap as it kicks the front diff in/out of engagement as the wheel speed sensor input is monitored for slip. The light in the dash is controlled by a feedback signal sent from the tcase servo, so the light will illuminate even if the case isnt locked or the front end locked. IE, on my '01 Jimmy the front end of my truck is still vacuum controlled via a vacuum servo under the right side battery tray, but the tcase shares the same servo unit. My light would ome on in the dash, propshaft locked, but font end still not loked due to a vacuum leak in the system. Full electric on the 1500-2500 is still the same except font end gets a signal from the servo instead of vacuum source.
The tcase servo do go bad often too, especially if its not installed correctly.
Its all junk really. Its why there are manual conversions available for them.