I have no experience on Colorado 4wD. I have quite a lot of experience on GM Blazers and Jimmys. Assuming that they are similar here is what I know. A flashing 2WD light says that you have asked for a shift to 2WD but it has not completed it yet. There is a switch mounted on the front axle housing that senses when the sliding gear inside on the right front axle has moved and disengaged. BTW, the 4WD light flashing says it is waiting to engage the front axle.
So most GM I have worked on had a vacuum diaphragm that pulled a long cable to engage the sliding gear. I have seen some that were electrical. In either case disengagement was the default no vacuum or no electric position. I can not remember if the switch or wire being open is engaged or disengaged. If it is not electrical (the switch circuit), Then it is the sliding gear itself.
I have also seen where it will do this because the front differential was low on fluid. So try looking at this first.
The next common thing is the gear chewed up a bit and the gear does not slide easily. To test if it is truly disengaged, you can jack up one wheel ONLY, not two, and spin the wheel by hand. Watch the front drive shaft (transfer case to differential) to make sure that it does not turn. It should not turn when only wheel is turned by hand in 2WD, Based on this test you should be able to tell if this is an electrical or mechanical problem and proceed from there.
It should be noted that the flashing light does not always go away immediately. You might have to drive it a block or two when cold or if there is a slight bind on the shifting gear from being in 4WD.
Good Luck.
