The 4WD light going on & off and the freewheel clutch engaging & disengaging will either be an air leak in the system or possibly a broken wire/bad connection.
The set up is triggered by a switch on the transfer case that grounds a wire leading to the 4WD controller, which can either be a separate module (up under the dash near the accelerator pedal), or integrated into the ECU (under the glovebox) - the 4WD controller then switches an air pump module (behind the front bumper) on & off as required, and the air flows through a hose to the front differential.
What I would do in your case is find the air pump connector and wire a 12V test lamp between the red & black wires (leaving the pump connected), position the lamp where I could see it from the driver's seat and then make another test - if the test lamp stays on the problem is going to be in the air side of the system, if the test lamp blinks out, the problem will be on the control side.
One important point - if the 4WD controller does not see feedback from the pump - it will shut the system down after 10 seconds, so if your test light only stays on for 10 seconds at a time, that's the reason.